Quant Hedge Funds Face China Clampdown After Rare Account Freeze

Bloomberg News
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(Bloomberg) -- China’s two main stock exchanges vowed to tighten supervision of quantitative trading after freezing the accounts of a major fund for three days in an unusually harsh punishment.

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The Shanghai and Shenzhen bourses will enhance monitoring of quant trading, especially leveraged products, according to statements late Tuesday. They will expand the scope of required reporting of such trades to offshore investors via the northbound mainland-to-Hong Kong stock connect and treat foreign and domestic funds the same.

The pledges came after the exchanges imposed trading bans on Ningbo Lingjun Investment Management Partnership, which dumped a combined 2.57 billion yuan ($357 million) in shares within a minute Monday when indices fell rapidly.

The moves mark an escalation in regulators’ efforts to tighten scrutiny of quant hedge funds following their rapid expansion in recent years, as officials seek to reverse a slump in stocks that’s now entering a fourth year. Quant funds have sought to dispel concerns that they can amplify market volatility and fuel routs.

While quant trading can help with market liquidity and price discovery, such trades have “obvious technology, information and speed advantages” over smaller investors and can “amplify market volatilities” at certain points, the exchanges said. Such transactions, especially high-frequency trading, are often regulated more strictly in overseas markets to “prevent negative impact on market order,” they added.

Quant hedge funds use computer models to capture trading opportunities in markets from stocks to commodities. Chinese quants often seek to beat certain benchmarks by buying a group of stocks that are similar to members of the underlying indices, while so-called market-neutral strategies would also hedge such exposure by shorting stock index futures.

‘Abnormal Trading’

Lingjun executed the sell orders starting from 9:30 a.m. as shares declined, “disrupting normal trading order,” the Shenzhen exchange said in a statement Tuesday. The Shanghai bourse imposed a similar freeze on the firm, which will be barred from trading stocks until Feb. 22.

Lingjun’s selling orders amounted to “abnormal trading behavior,” and the firm was warned multiple times for the same reason this year, according to the Shenzhen statement. The bourse will tighten supervision and maintain “zero tolerance” on any activities that harm investors’ legitimate rights, it said.

Beijing-based Lingjun will “resolutely comply” with the bourses’ restrictions and learn its lesson, the company said in a statement posted on its WeChat page. The investment accounts under its management bought a net 187 million yuan in shares on Monday, it added.

Lingjun has always been “bullish and long on the Chinese equity market, and we are always close to full stock positions,” the company said. It also pledged to ensure “smooth and balanced transactions” by improving its trading models and strictly controlling transaction processes. Lingjun is among the four-biggest quant funds in China, with more than 10 billion yuan under management.

In addition to the regulatory curbs, a recent slump in small-cap stocks is posing fresh challenges for quants. Private quant funds suffered a 7.2% average loss in January, according to Shenzhen PaiPaiWang Investment & Management Co., underperforming the benchmark CSI 300 stock index.

Read more: Quant Hedge Funds Suffer Rare Losses in China Stock Meltdown

Quants’ models suffered a “major impact” in the two weeks preceding the Lunar New Year, as the market was seized in panic and “lots of irrational trading” ensued, Lingjun wrote in an investor letter seen by Bloomberg. As safety-seeking money piled into member stocks of CSI 500 and CSI 1000 exchange-traded funds in the week of Feb. 5, such shares rose significantly, prompting many fund managers to adjust their stock portfolios to mimic the underlying indices, it said. Such behavior caused a “liquidity stampede” away from shares not included in the rising gauges.

Adjusted Model

While Lingjun also adjusted its model and refocused its stock exposure to the top 1,800 listed companies by market value, its returns relative to benchmarks still suffered, according to the letter, dated Feb. 20. The company has upgraded its strategies over the holiday, and pledged to recoup its alpha “as soon as possible.”

China’s securities regulator made another move this week that underlines its resolve to shore up the nation’s $8.6 trillion stock market. The China Securities Regulatory Commission, led by new Chairman Wu Qing, will treat opinions, suggestions and criticism from all parties seriously and implement the “pragmatic and feasible” ones immediately, it said in a statement after holding a series of seminars with investors, listed companies and foreign institutions over the past two days.

Quants have faced other regulatory impacts in recent weeks. China’s commodities exchanges ended commission rebates on some programmed trades this year, and authorities barred quants from cutting stock positions on certain products earlier this month in a bid to stem the market rout.

Various stimulus measures from Beijing have helped China stocks recover in recent days, though the CSI 300 Index is still down less than 1% for 2024, after dropping for three straight years.

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