Regulatory flaws expose weakness in market rules

Peng Zhenggang, CEO of Hundsun Technologies Inc. [Photo/IC]

HOMS system, a little-known securities trading software until recently, has been allegedly viewed as the prime culprit for the dramatic stock market slide in the past few weeks, raising questions of whether the country's financial regulation is matched with its high levels of technology and financial innovation.

Leveraged funds worth trillions of yuan had flown into the equities market through the HOMS system, which fueled a frenetic bull run, and triggering the recent 30 percent plunge due to massive deleveraging and liquidation of margin accounts.

The market turmoil has already prompted the regulator to take tough steps toward cleaning up gray-market margin lending through non-brokerage channels that allow investors to borrow up to 10 times their initial capital to trade stocks through the HOMS system.

On Monday, officials at the China Securities Regulatory Commission made a surprise visit to the office of Hundsun Technologies Inc, the company that developed the HOMS system, to verify relevant details, and urged all involved to strictly abide by the rules, CSRC spokesman Deng Ge said.

The company, backed by Jack Ma's e-commerce giant Alibaba Group Holding Ltd, defended its role, saying that it is unfair and irrational to blame its system for the market decline.

Only 30.1 billion yuan ($4.87 billion) was forcefully liquidated through the HOMS platform from June 15 to July 10, accounting for 0.1 percent of the total transaction volume during the period, Hundsun said.

The HOMS cloud-based system, launched in May 2012, was originally designed to offer private equity funds a solution of dividing one account into multiple sub-accounts and allow fund managers to operate them simultaneously. The system is claimed to help improve operation and risk management efficiency.

But financing firms and online peer-to-peer lenders have taken advantage of the system by connecting their accounts to securities brokerages through the HOMS system and operate highly leveraged margin trading for their clients through multiple sub-accounts.

There has been no official data on the level of funds that have flown into the stock market through the gray-market margin lending, because it was a blind area in the regulatory system.

Industry experts said the event offered important lessons in financial regulation.

"The fact is that the market will keep innovating itself. It will be challenging for the regulators to keep pace with market development while ensuring effective regulations and risk control," said Li Daxiao, chief economist at Shenzhen-based Yingda Securities Co Ltd.