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What if JPMorgan’s multibillion-dollar “London whale” trading losses had led regulators to ban Jamie Dimon, chief executive, from markets for life and forbidden the bank from ever investing again in credit derivatives?
Such a draconian scenario might sound far-fetched in the US or Europe. But this is exactly the scale of the punishment that has been meted out in China against Everbright Securities, after the brokerage committed a massive trading error two weeks ago, and tried to conceal it.
The Everbright scandal has received scant attention outside China – which is perhaps understandable given the closed nature of the country’s markets: few foreign institutions or investors have been directly affected by it. Yet it is an extraordinary story that merits a closer look, because it exposes the ugly underbelly of China’s brokerage industry and shows that regulators are serious about whipping it into shape.
The troubles for Everbright began on the morning of August 16. A software error led the brokerage to place buy orders for about 3bn shares instead of the 30m it had wanted to acquire. The sudden surge in demand fuelled the biggest one-day stock market rally in China for years. The Shanghai Composite, the country’s main index, shot up 6 per cent in the two minutes before the end of the morning session.
During the lunch break – when analysts and investors were still puzzling over the cause of the rally – traders at Everbright Securities realised it was their own computer malfunction that was to blame. But, rather than informing the stock exchange, they decided to profit from their error by selling their positions in exchange traded funds and also shorting index futures – guessing that the market would fall when the mistake was publicly announced. A little more than an hour later, that is precisely what happened.
On Friday, only two weeks after Everbright’s “fat finger” trade, the securities regulator fined the brokerage Rmb523m ($85m) – more than half its 2012 profits and a record in China. It also banned four employees from China’s securities market for life, including Xu Haoming, president since 2005, and barred Everbright from proprietary trading in the stock and futures markets.
Commentators have since drawn parallels between Everbright’s mistake and the software glitch that caused Goldman Sachs to send out thousands of orders for option contracts in 17 unruly minutes of trading last month – also triggering a brief spike in prices.
Commentators have drawn parallels between Everbright’s mistake and the software glitch that hit Goldman Sachs last month
However, there are big differences in how the errors were handled. The exchanges affected by the Goldman error quickly detected the unusual activity and subsequently voided many of the contracts. Senior executives at Chinese brokerages have expressed concern that neither the Shanghai Stock Exchange nor the China Financial Futures Exchange appeared to have emergency brakes to deal with similar chaos. The shorting of index futures by the Everbright traders was also a particularly brazen attempt at profiting from information that should have been in the public domain. That they believed they could get away with such shenanigans when all eyes were on the stock rally is an indication of just how rampant insider trading is in China. Until recently, big brokerages have consistently escaped with minimal penalties, helping to foster a culture of entitlement.
But things are starting to change. Xiao Gang, China’s securities regulator since March, has been on a crusade to clean up the industry. Five brokerages have been suspended or investigated for misleading investors about share offerings that they underwrote. It is the first time brokerages have been barred from sponsoring initial public offerings since 2006.
The Everbright case looks set to become a catalyst for further positive change. What makes its punishment all the more astounding is the brokerage’s pedigree. Everbright Securities is a subsidiary of Everbright Group, one of China’s leading state-owned financial conglomerates, and it was the country’s seventh-biggest securities company by assets last year. None of that was enough to protect it. Its Shanghai-listed shares have plunged 25 per cent over the past two weeks.
Xi Jinping, China’s president, has vowed to target both “tigers and flies” – top leaders and lowly bureaucrats – in his campaign against corruption. This approach now has a parallel in financial regulation: authorities have shown they will hold management directly accountable for the actions of traders. It is regarded as tough justice but the right medicine for an industry long plagued by abuses.
Simon Rabinovitch is the Financial Times’ Shanghai correspondent
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