New Investment Tools Approved by Regulator in China

China took a major step toward making its capital market system more sophisticated and perhaps more stable as it agreed to give investors a new and powerful set of risk-management tools.

Photo by: Cory Doctorow

The government said it had approved, “in principle,” the creation of stock index futures, trading on margin and short selling, investment tools that are commonly used in New York, Chicago, London and many other financial markets, according to Xinhua, China’s state run news agency.

The announcement means that for the first time investors in China have more options than simply buying and selling their favorite stocks. They will soon be able to invest in a stock index (or set of stocks, collectively) and borrow money to trade stocks on margin.

Investors will also be able to make financial bets that stock prices will fall, a practice called short selling.

“This is a major step for China’s capital markets,” said Chang Chun, a professor of finance at the China Europe International Business School in Shanghai. “The government has been studying this for a long time.”

The China Securities Regulatory Commission said on its Web site Friday that it may take three months to complete preparations for the new investing tools to become available.

“This improves the stability and the healthy development of the capital markets,” the C.S.R.C. said in its statement.

By approving the new tools, the government hopes to accomplish several goals, including giving Shanghai more credibility as a financial capital and encouraging more ordinary Chinese to invest in equity markets. Many households still keep a large amount of their savings in low-interest accounts at state banks.

The announcement Friday did not come as a surprise to investors here.

Rumors that such an announcement was imminent have excited market players in recent days.

They drove up the share prices of Chinese brokerage houses, which expect to cash in on the new rules by making margin loans to investors and giving them additional options to hedge their risk.

Jing Ulrich, chairman of China Equities and Commodities at JP Morgan, said in a report released late Friday that the new investment tools will help institutional investors who want to hedge and reduce volatility in a market that is known for wild price swings.

Mainland China’s benchmark Shanghai Composite index almost doubled in 2007, then slumped 65 percent in 2008 before rebounding about 80 percent last year.

The government has been eager to offer investors additional tools for some time.

In 2006, Beijing established the China Financial Futures Exchange in Shanghai. Since then, regulators have been testing stock index futures, short selling and margin trading.

But regulators delayed approving the practices because of the global financial crisis and because of worries that such trading could disrupt the country’s volatile stock exchanges in Shanghai and Shenzhen, analysts say.

The Chinese government has worried that short selling and trading on margin in particular could be abused by investors and increase speculation and chaos in the market.

Short selling and derivatives trading have come under sharp scrutiny in the United States and elsewhere, because of similar worries about whether they improve or distort markets. In 2008, the United States and other countries imposed a temporary ban on short selling of financial stocks. The bans were lifted after several months.

The Shanghai and Shenzhen exchanges only began to take shape in the early 1990s, when Beijing pushed to develop a financial market system. Exchanges in Hong Kong, a former British territory that reverted to Chinese control in 1997, have long had such offerings, because they operate independently of Beijing.

Now, Shanghai is eager to establish itself as a financial center that can compete with Hong Kong, and even New York. The city is building a huge financial center in the Pudong district, trying to lure Wall Street executives and giving private equity firms incentives to establish offices here.