(Bloomberg Gadfly) -- Manipulating Chinese stocks from Hong Kong is about to get harder. That's the good news, for investors interested in fair and transparent markets. The bad news is that it raises the specter of increased Chinese surveillance of investors in the city.
By the middle of next year, buyers of equities via the Hong Kong exchange's trading links with the mainland will have to disclose who they are through an investor ID system, according to the head of the city's Securities and Futures Commission.
The requirement is more invasive than current global norms that deny regulators direct access to that information, forcing them to request it from the brokerage through which a trade is performed. (The MiFID II regulations that come into force early next year will see the introduction of an identification system in Europe.)
Until now, any investor in Chinese shares wanting to cloak their identity could route trades through Hong Kong using the so-called connect programs set up with Shanghai in November 2014 and Shenzhen last December. Such anonymity isn't possible in the mainland, which introduced strict ID requirements after a spate of scandals in the early 2000s when many brokers were accused of stealing stocks. All traders need an ID registered with the stock exchanges and clearing house; the system gives regulators access to other information besides identity, including how much cash investors have in their accounts.
Investors concerned about their information being passed on to Chinese authorities can be assured that the SFC held back from adopting a mainland-style approach. Hong Kong's ID system will drill down only to the level of the trader, rather than the ultimate individual owner. Buying through a fund, for example, will continue to assure some anonymity.
Most fund managers are relieved that the ID requirement won't go deeper, according to Eugenie Shen, head of the asset management group at the Asia Securities Industry and Financial Markets Association. "The operational and administrative burden of operating an ID system down to the ultimate beneficial owner level would be very high," Shen said.
Hedge funds and other professionals might fret that a full-disclosure system would open them to the risk of information leakage that would tip off other investors on their trading strategies. In truth, though, the ID move is primarily aimed at Chinese investors who are using Hong Kong as a convenient platform to play the markets back home.
A case in point: In March, the Chinese Securities Regulatory Commission fined Tang Hanbo the equivalent of about $170 million in two cases of market manipulation, one of which was the first to involve trading through the stock connect between the mainland and Hong Kong. Tang, who had been punished for illegal trading at least twice before, used the link to manipulate the Shanghai-listed shares of Zhejiang China Commodities City Group Co.
At some point, the ID system will be extended to mainland investors trading Hong Kong stocks, SFC Chief Executive Officer Ashley Alder said this week. That could help combat manipulation of the city's stocks, a rising problem that is worrying the securities regulator.
More money has flowed into Hong Kong than in the other direction via the connect programs this year -- 520 billion yuan ($79 billion) versus 315 billion yuan into Shanghai and Shenzhen stocks, according to Alder.
While privacy will remain a concern for foreign investors, Hong Kong looks to have struck a reasonable balance. With MiFid II, there is a global trend toward more transparency in markets. Better for Hong Kong and China to be taking such action at a time when billions of dollars of foreign investment are flowing in than during a drought.
If identity disclosure helps to create fairer and more trustworthy markets, then it will be a price worth paying. There's no free lunch.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
Nisha Gopalan is a Bloomberg Gadfly columnist covering deals and banking. She previously worked for the Wall Street Journal and Dow Jones as an editor and a reporter.