Recent development of the situation in the stock market presents opportunities for investors and regulators

Written by Paolo Di Fonzo || January 11 2016

The RMB-USD exchange rate has two different values: the onshore value, determined by the PBOC at markets opening, and the offshore value, which is market-driven and used in Hong Kong. These two rates were usually almost identical, until August 2015 when a surprise depreciation by the Chinese central bank caused an even deeper depreciation in the offshore value, with the spread between the two starting to become significant, especially towards the end of the year when the yuan continued to lose value in comparison to the US dollar.

This created an opportunity for arbitrage trading: buying in Hong Kong and selling in Shanghai became a sure profit, which is why several banks, including Standard Chartered and Deutsche Bank, started operating this way.

Problem: the no-arbitrage condition is a fundamental rule, so the PBOC was forced to intervene, imposing a three months ban (or less in some cases) on those lenders who were caught in this kind of trades.

While this exploit was stopped with a firm hand, it presents one of those occasions in which the current downturn of the Chinese financial structure is creating opportunities for investors with a strong risk appetite.

Another example is that there are those stocks under-priced because of the overall scenario, but that actually should represent good investments for the future, once the market has re-balanced and the picture becomes cleaner.

There are also those suggesting how all this madness is just a façade, with the government having actually planned everything beforehand. While this seems laughable, it could be in a way closer to reality than what it looks like: the idea is that it would be very strange if Chinese authorities did not foresee what it is happening and, although almost certainly they did not intended to take this route, it is more than possible that they already planned what to do and started acting way before January. This theory however has a glaring hole: institutions do not seem to be acting in concert.

The already fundamental role of the People’s Bank of China is going to another level, as it tries to manage the chaos that has returned to markets after a relatively calm autumn. The problem is that this same goal is being pursued by the CSRC, but oddly, the two legal entities do not seem to be communicating or collaborating much, something that was already noted by the Chinese government itself during the summer.

An example of that was when the CSRC decided to take away circuit breakers on the same day the PBOC announced a cut in the interest rates, which resulted in augmented instability as foreign investors were even more incentivised to move away from the Chinese market.

For all the speculation that the government was contemplating a mulling of regulators, this should be the right moment to translate that speculation into reality, for the Chinese authorities cannot afford an indecisive action.