Hedge funds, brokerages probed on two-way profits

As China's stock markets struggle to recover, regulators have started to probe hedge funds and brokerages on quantitative trading strategies amid a growing outcry against a sector able to profit from share price falls and volatility.

The China Securities Regulatory Commission has checked with several major brokers in past weeks about short-selling activities and trading strategies of their quant clients - funds that trade rapidly using derivatives and data-driven computer models.

And the Shanghai and Shenzhen stock exchanges, under the CSRC's guidance, have sought information from major quant funds on strategies.

Global quant fund houses including Winton and Two Sigma have operations in China, but it is not clear if foreign players are being probed.

The latest regulatory scrutiny comes after a slew of market-friendly measures - including a stamp duty cut - failed to drive a sustainable rally in a struggling market.

The weakness has triggered finger-pointing in social media as well as criticism from fund managers and retail investors against quant funds and short sellers.

The CSRC has vowed to increase scrutiny over program trading, and some fear fresh probes could lead to tighter regulations on short-selling and certain financing activities by hedge funds.

Quant funds in China exceeded 1.08 trillion yuan (HK$1.18 trillion) at the end of 2021, nearly doubling in size from a year earlier.

Some of China's biggest quant funds include High-Flyer Quant Investment, Yanfu Investments and Shanghai Minghong Investment Management.

A better understanding of quant strategies may lead to regulators curbing those that contribute to volatility.

Short-selling activities by quant funds could also be caught in the crossfire.

"Brokerages in China are more willing to lend securities to quants for shortselling due to their active trading and commission contributions," said Yuan Yuwei, a fund manager at Water Wisdom Asset Management. "But it's unfair to other market players who hardly have access to securities lending."

The regulatory inquiry is still in its early stage and no conclusion has yet been reached.

Regulators have also asked for data around direct market access. Through DMA hedge funds in China can borrow money from brokerages to fund leveraged bets.

"DMA raises eyebrows as it involves high leverage and allows quant funds to make a lot of money," said a brokerage source.

Another brokerage source said the CSRC asked it to elaborate on the size of their quant clientele and whether quant trading had impacted on the stock market recently.

Yang Tingwu, an executive at asset manager Tongheng Investment, supports tighter rules for quant funds, arguing many Chinese quants make lucrative bets on poorly managed companies based on momentum signals rather than fundamentals.

Quant strategy is a neutral tool, he said, but "in China it's being used to provide liquidity to the bad guys" - a reference to listed firms with poor governance.