Institutional investors key to Chinese market recovery: Nasdaq chief

Are stock exchange link-ups still relevant?

Market volatility and expectations of an economic slowdown are spurring a record amount of capital outflow from China. To turn things around, Beijing must turn to long-term institutional investors to boost its stock market, Nasdaq President Adena Friedman told CNBC on Wednesday.

Friedman said institutional investors, such as banks, insurance companies, and pension funds might hold the key to lifting the gloom and doom surrounding China's markets. Their participation could bring much-needed balance and liquidity during times of volatility.

Confidence in the Chinese markets plummeted after a massive sell-off earlier this year. A series of contradictory policy steps aimed to shore up sentiment only added to the confusion.

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As a result, China's capital account deficit for the first half of 2015 was $125.6 billion, with nearly $40 billion capital flowing out between May and June, Reuters reported.

The situation worsened after the Chinese central bank unexpectedly devalued the yuan in August. China instructed brokerages to buy shares to prop up the market but the impact of such intervention is likely to be limited.

"The more that they can bring institutional order flow, and long-term investors, into the markets, the better off they're going to be in not having to intervene when they see market volatility," she said.

Chinese stock markets are dominated by individual retail investors who trade small volumes of stock in the short term.

Reports suggest they are often inexperienced, invest with borrowed money and a faith in the government to intervene when times are tough. They were some of the hardest hit stakeholders during the stock market rout.

An investor in front of an electronic board showing stock information at a brokerage house in Fuyang, China, July 28, 2015.

Foreign investors can currently buy stocks in the mainland through the Hong Kong-Shanghai Stock Connect. There are restrictions on the amount of shares that can be purchased though.

Attracting big institutions would require Beijing to provide robust infrastructure in their domestic markets that would allow smooth order flows and new investor participation without hold-ups, said Friedman.

Institutions must "feel there's a long term gain that they can provide to their investors; there's a fair environment in which to operate, [and] that it's frictionless."

They should also be allowed to execute their complex strategies, which often involve short-selling, without facing any regulatory pressures, she said.

Chinese regulators have stepped up their crackdown on short-selling by introducing new laws to dissuade speculators from profiting off sharp swings in the market. The Shanghai and Shenzhen exchanges introduced rules that banned same-day borrowing and repaying of stocks, according to reports.

Friedman said these structural and policy changes had to be developed gradually. "I'm not sure you can force institutional order flow into a market," she said.