Why China’s Stock Market Faces Potential Dangers of Illegal Trading

China national flag

Infamous trader Nick Leeson has a word of warning for China’s equity markets. His message is loud and clear. Improve regulations and transparency, or risk losing billions at the hands of rogue traders.

Back in 1995, Leeson was a trader for Barings Bank in Singapore.

Things took a turn for the worst when Leeson began to lose money. He attempted to hide the losses through unauthorised trades.

There were no stringent regulations to stop him either. The Singapore stock exchange (SGX) was underdeveloped at the time. He could trade freely without fear of detection.

Leeson’s recklessness led to losses of $1.4 billion. His employer, Barings Bank, collapsed as a result. International markets exposed to the SGX lost money due to Leeson’s actions.

Why China’s market resembles the Singapore Exchange

The problems found in Chinese equity markets today are similar to the SGX of 1995. The SGX wasn’t capable of handling large volumes of trade. Leeson thinks China’s market infrastructure is now becoming overwhelmed by the number of buy orders coming in.

He thinks this frenzied trading activity stems from plans to connect the Shanghai and Hong Kong markets. That’s leading to millions of new trading accounts.

Trading volume on Chinese markets reached a high of $38 billion on April 9. And the average number of transactions is double what it was a month ago.

Leeson says that Chinese regulators are unable to handle the sheer amount of volume being traded. This is what has him concerned that China’s situation is starting to resemble the SGX’s.

Leeson’s story is an example of why poorly regulated markets are at risk of increased illegal trading activity.

How Chinese regulators plan to combat rogue traders

Chinese regulators issued a cautious response to Leeson’s concerns. They’ve said they’ll come down hard on any unusual share movement. But it remains to be seen whether that’s enough to convince international authorities.

China is currently lobbying various companies to include its $7.8 trillion equities market on global indices. This would further professionalise China’s stock market. It would bring it more in line with international practices and regulations. China wants this because it would give the yuan a greater role in world finance.

But to achieve this China will have to build a more ‘predictable’ financial system. That means China’s inclusion on global indices will depend on its ability to provide proof of share ownership. In other words, they need to reduce the potential for rogue trading.

It goes without saying that this matters for inclusion on global indices. That’s because international markets would become more exposed to Chinese stocks. And this would increase the risk of illegal trading spilling over into global markets. It works the other way too.

If China doesn’t ramp up stock market regulations, then it risks attracting international rogue traders to its markets. That would only add to concerns for the future stability of Chinese stock markets.

China’s burgeoning equities market means they’ll need to address concerns over illegal trading soon. Not doing so would risk wiping out an untold amount of wealth in the future.

Mat Spasic,

Contributor, The Daily Reckoning

PS: It’s not just illegal trading that concerns equity analysts. World markets are continuing to boom in 2015. And it’s not just China feeling the effects. The ASX market cap is up to almost $1.8 trillion. Some believe we’re already in the bubble of all bubbles.

The Daily Reckoning’s Vern Gowdie believes we’re going to see a catastrophic crash in stocks. The ASX could lose as much as 90% of its value.

That’s why Vern’s written ‘Five Fatal Stocks You Must Sell Now’. In this free report he identifies the five blue chip companies which could destroy your wealth. And you almost certainly own one of them.

Vern wants to help you avoid the coming wealth destruction. His report will show you why these five stocks will the first to damage your wealth. To find out how to download the report, click here.

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The Daily Reckoning
The Daily Reckoning offers an independent and critical perspective on the Australian and global investment markets. Slightly offbeat and far from institutional, The Daily Reckoning delivers you straight-forward, humorous, and useful investment insights from a world wide network of analysts, contrarians, and successful investors. Founded in 1999, The Daily Reckoning is published in 7 countries with a worldwide readership of almost 1 million people.

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