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More supervision needed to prevent illegal trading

By  Li Yunfeng (Global Times)

09:05, July 19, 2012

In 2004, the Chinese government banned fund managers from investing in stocks in an attempt to prevent them from exploiting their position in the market and their clients' money to manipulate share prices, a practice known popularly as "rat trading."

This ban could soon be lifted though, despite staunch opposition from experts and investors. Earlier this month, the government issued a series of draft amendments to securities laws which would make it legal for fund managers to invest in the equity market as long as they complete a registration process with their firms and disclose how much money they intend to invest.

For the sake of the market and regulators, I think the time has come for the government to abolish this restriction on fund managers.

Over the past eight years, regulators have been fighting an uphill battle to eradicate illegal trading by these managers, almost all of whom are expert investors and very resourceful when it comes to keeping their equity positions under wraps. In fact, most cases of rat trading have been brought to light not by regulators, but by insiders or whistle-blowers who voluntarily came forward to authorities when problems related to profit distribution emerged.

Also, as sophisticated fund managers can earn much more from investing in the market than they can from their commission fees, this barrier has forced many capable and law-abiding managers to quit their jobs to pursue their own investments. As a result, the industry has become full of less qualified managers.

But, if it became legal for fund managers to trade stocks, it would do away with many of their incentives to evade oversight and would keep the best managers in the field - a development most fund investors would surely welcome. At the same time, these highly knowledgeable investors could provide guidance to retail investors and help stimulate the bearish market.

Instead of erecting barriers to keep fund managers away from stock investments, the government should instead establish an effective system to monitor their trading activities in order to prevent conflicts of interest.

In many countries with developed stock markets, fund managers are allowed to hold equity stakes if they submit to strict regulatory oversight. In the US, for example, securities laws prohibit fund managers from trading stocks in their own fund products. Also, every time a fund manager buys or sells stocks, they are required to report this transaction to their firm. China could learn much from such practices.

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