EAGER INVESTORS: Investors watch a stock market quotation list at a branch of a securities firm in Shenyang, Liaoning Province (LI GANG)

The business practice of margin trading and short selling, which originated in the United States in 1934, is being incorporated into the Chinese capital market. As tests organized by the China Securities Regulatory Commission (CSRC) come to a close, information from industrial insiders indicates the CSRC will launch a pilot program of margin trading and short selling at the beginning of March.

Allowing investors to borrow money to buy securities or borrow securities to sell, margin trading and short selling have become common business practice on the capital markets of many countries worldwide. However, because the Chinese capital market only has a history of 20 years, the CSRC is prudent to launch the business out of fear of unnecessary risks.

High standards

According to the CSRC, the design for the Chinese margin trading and short selling system incorporates experiences from overseas markets in China's rules and operating mechanisms and combines characteristics of the Chinese market. With complete systems and rules, possible margin trading and short selling risks will be minimized and kept under control, bringing risks to neither clients nor securities firms.

Simply being cautious is not the only measure in the CSRC's arsenal. It also set a high threshold for prospective margin traders and short sellers. To participate, a client must have an open trading account for more than 18 months. The total assets of the securities account should be greater than 500,000 yuan ($73,206), and the total financial assets should be more than 1 million yuan ($146,413).

The monetary requirement prevents common investors from participating in the margin trading and short selling business. According to figures released by China Securities Depository and Clearing Corp. Ltd., by the end of 2009, A-share accounts with assets exceeding 1 million yuan each had accounted for less than 1 percent of the total number of accounts.

Wang Xiaoguo, Deputy Director of the Development and Strategy Working Committee of the Securities Association of China (SAC), said he once suggested relaxing the restrictions. As for the capital threshold, he suggested referring to the New York Stock Exchange Regulation and the NASDAQ Stock Market, which stipulate a $2,000 minimum equity requirement to initiate margin trading and account opening minimums of $2,500 for brokerage accounts.

As for transaction experience, Wang suggested referring to provisions from Taiwan that stipulate a trustee's trading account must be opened for more than three months, there are more than 10 transactions within the past year and the accumulated trading amount surpasses 50 percent of the applied amount of margin trading.

Wang's suggestion was not accepted.

Many industry insiders think the Chinese threshold of margin trading and short selling will be higher and is unlikely to be lower than the present provisions.

Differing from the CSRC's focus on preventing risks and restricting investors, most clients are strongly interested in the margin trading and short selling business. According to securities firms such as China Securities Co. Ltd. and Guodu Securities Co. Ltd., many clients have called, looking for information about trading.

In the Chinese securities market, investors can make money only when stock prices increase. Similarly, they can buy low and sell high. Without the margin trading and short selling mechanism, during a bear market investors have no way to avoid risks except for leaving the market temporarily.

With margin trading and short selling, investors can make money when stock prices increase or decrease. They have one more opportunity to turn loss into profit: During a bear market, they can avoid risks by borrowing securities to sell—the main reason investors are actively preparing for the new mechanisms.

Another attraction to investors is that margin trading and short selling have the effect of financial lever, allowing investors to acquire capital or stock surpassing their own capital to expand their trading capabilities and improve the capital utilization efficiency of investors.

Hence Chinese investors hope the threshold to margin trading and short selling can be reduced as the business is improved when put into practice.

Trial qualification

On February 1, the stock price of CITIC Securities Co. Ltd., a securities company that had benefited from the margin trading and short selling business, dropped 6.51 percent. Analysts said this was due to investors worrying the company would not qualify for the first batch of trial companies because of the hard provisions by the CSRC.

Under the provisions, each shareholder can only control one securities company and be the holder of another securities company. But the half-yearly report of CITIC Securities Co. Ltd. in 2009 showed the company held 100 percent, 91.4 percent and 60 percent of shares of CITIC Kington Securities Co. Ltd., CITIC Wantong Securities Co. Ltd. and China Securities Co. Ltd., respectively. Therefore CITIC Securities Co. Ltd. has to reorganize the securities firms it controls by selling shares to meet the supervision provisions.

"This proves the significance of margin trading and short selling to a securities company. All securities firms hope they can be selected for the trial," said Chen Hongwei, a researcher at Guodu Securities Co. Ltd.