Experts call for stricter regulation in PE industry

Potential risks warned in high-frequency and quantitative trading in case of market volatility

While private equity has boomed in China over the past few months, its performance has been polarized and more regulations should be put in place, market experts said.

Shenzhen Rongzhi Investment Consultant, a tracker of the Chinese PE industry, said at least 20 PEs have seen their value amounting to over 10 billion yuan ($1.6 billion) so far this year. As of Sept 10, there were 91 Chinese PEs meeting that gauge.

Shenzhen-based Century Frontier Asset Management and Shanghai-based Jin Ge Asset Management met the 10-billion-yuan benchmark at the end of August. Both specialize in quantitative trading. Therefore, there are 20 quantitative PEs seeing their respective value topping over 10 billion yuan in China, Rongzhi said.

Based on mathematical functions and modern technologies, quantitative trading is conducted through a computer program that applies models to historical market data. Taking off globally in the late 1980s, quantitative trading is more often used by financial institutions and hedge funds and involves a large amount of the purchase and sale of securities.

Despite their thriving scale, Chinese PEs have posted a diverging performance over the past few months. For the 10-billion-yuan PEs, 78 have announced their business results, with the average gain coming in at 9.42 percent this year. The CSI 500－a key index measuring small to mid-cap A-share companies－has jumped more than 18 percent during the same period.

PEs focusing on long positions of stocks have turned in poor results in general the past few months, especially those featuring value investment. Six 10-billion-yuan PEs using such an investment strategy, including industry major Tongben Investment, reported losses of more than 10 percent this year, Rongzhi said.

On the other hand, PEs adopting quantitative investment strategies has boomed for a good reason, with at least 10 reporting over 20 percent profit this year, as calculated by Rongzhi.

As of the end of August, most products under quantitative investment strategies have shown stunning gains, which has raised concerns from the market and regulators, said Fan Shuyi, senior analyst of Shanghai-based financial services provider Noah Holdings Ltd.

Some leading PEs said that they have received inquiries from regulators on their operations. Concerns were expressed that the increasing trading volume on the Shanghai and Shenzhen bourses, which remained above 1 trillion yuan for 41 consecutive days by Sept 15, can be largely attributed to quantitative trading, Fan said.

"But actually, quantitative trading is an important tool to discover prices. They have facilitated trading and helped to increase market liquidity," she said.

Quantitative trading started in China in April 2010 when the index futures of CSI 300 was rolled out. The product serves as an important hedging product for quantitative trading and provides room for various quantitative strategies such as alpha strategies and index arbitrage.

During the annual meeting of the World Federation of Exchanges held in early September, Yi Huiman, chairman of the China Securities Regulatory Commission, said quantitative and high-frequency trading have been widely adopted in mature markets.

While such trading modes have helped to increase market liquidity and enhance pricing efficiency, they are prone to resulting in the convergence of trading and higher market volatility. They may also sometimes infringe on market fairness.

Quantitative trading has leapfrogged in China over the past few years. Exchanges and market practitioners should make more thorough studies into market capital and new types of trading tools, Yi said.

Ma Xixun, vice-general manager of Shanghai-based quantitative asset management firm XY Investment, said high-frequency trading has brought in satisfactory profits over the past two years as trading has been active in the A-share market and the daily fluctuation has been significant. But the trend may not be sustainable in the future.

Therefore, quantitative trading based on fundamentals, which is based on companies' growth and the capital market's wrong pricing, will bring more investment opportunities.

Based on the experience of overseas markets, more than 80 percent of quantitative investment is based on fundamentals, while less than 20 percent focuses on high-frequency trading and other strategies, he said.

A guideline released in October 2015 by the CSRC, the country's top securities regulator, defined programed trading as activities which are automatically generated or executed via established or specific software. Institutions taking part in such trading should make applications in the first place and can only proceed with permits. Extra fees are charged for programed trading.

Xiong Jinqiu, a senior independent capital market analyst, said there should be crackdown on violations in programed trading. The country's new Securities Law, which took effect in March 2020, said the frequent or large amount of offers and consequent withdrawals, none of which are conducted for the purpose of clinching deals, should be considered market manipulations.

"Programed trading may incur the above misbehaviors, some of which is meant to create trading congestion or exploring other investors' willing offers. All these should be considered market manipulations and should be severely punished," Xiong said.