(China-Based and Foreign) Market Makers for Chinese Assets: The Good, Bad and Potentially Ugly


As mentioned in the article through which we have put the brokerage dimension of China’s financial services sector under the microscope, foreign investors aren’t always flocking toward Chinese assets such as stocks, not at this point at least, for reasons which vary wildly and go well beyond the scope of this post.

Suffice it to say that this oftentimes leads to… well, liquidity problems.

You can trade Chinese assets in a wide range of settings, for example there are even over 100 companies listed on Nasdaq. However, the liquidity dimension is oftentimes problematic, let’s just say these entities are anything but Apple in terms of liquidity. In extreme situations, this can even result in you as a Chinese asset owner realizing that there are very few buyers for your asset should you choose to sell now, with you most likely having to settle for a sub-optimal price to find liquidity.

Normally, entities called market makers step in to fill this void. These entities, usually large financial institutions, both sell (ask price) and buy (bid price) a certain asset, making money from the so-called spread, which is the difference between the ask price they receive when selling and the bid price they pay when buying. For example, they might set an ask price for a certain stock at $1,003 (the amount they are willing to sell for) and a bid price of $1,000, pocketing the $3 difference between the two. In the absence of such market makers, liquidity levels would plummet and, needless to say, spreads would go up, much to the frustration of buyers as well as sellers.

Unfortunately, sticking to our Nasdaq example, market makers tend to favor companies such as Apple when it comes to choosing where to provide liquidity, with Chinese companies not really in the spotlight.

Does this mean there is no hope?

Of course not, progress is (gradually) being made.

For example, once again to remain in Nasdaq territory, Haitong Securities became the first China-based market maker allowed to conduct business on the exchange. While initially only allowed to be a market maker for two Chinese companies, more specifically JD.com (the Best Buy of China, if you will) and Baidu (China’s Google), it represented an important first step and Haitong Securities ended up also handling the US IPO of Puxin.

Again, gradual progress is indeed being made.

But can market makers be trusted or is their presence a bit of a double-edged sword?

The answer to this question is heavily jurisdiction-dependent. In let’s say the United States in general and Nasdaq in particular, you at least know that for better or worse, the activity of market makers is reasonably (enough) regulated. As such, while shenanigans are never truly out of the question, you can at least expect a decent layer of legislative robustness to act as a bit of a buffer between the more or less ethical ambitions of some market makers and the legal framework they are forced to operate in.

If, however, we are talking about more exotic jurisdictions, then the legislative safety net dimension starts becoming more and more debatable. From brokers who are also market makers (in and of itself, it is worth pointing out that there is nothing wrong with brokers also making markets) and engage in unethical short and long short squeezes (mis)using information they possess to market makers who collude with brokers so as to gain access to information that enables them to hunt down positions, there are without a doubt risks involved if market making isn’t legislatively confined.

Finally, we will not end this article without making it clear that market making has changed dramatically over the years. Gone are the days when an actual person was typing in bid and ask prices by hand, the days of NYSE “specialists” and what not. At this point in time, market makers tend to be high-frequency trading operations that employ some of the brightest mathematical minds so as to automate everything via algorithms and deploy impressive digital firepower (processing power) so as to squeeze even the last millisecond out of each transaction.

It would be the understatement of the (21st) century to merely state that these organizations can out-spend the average investor, out-smart the average investor and out-process the average investor. All the more reason to make it clear that market makers who operate in the oftentimes murky waters of various exotic jurisdictions can do quite a bit of damage. As a bit of an extreme example of what brokers and/or market makers can “accomplish” when they are “unshackled” of legislative concerns, we have the cryptocurrency world, where exchanges such as the Seychelles-incorporated Bitmex together with so-called whales (oftentimes Chinese whales) represent a potentially deadly combination with respect to liquidating unsuspecting retail traders, to the point that Bitmex itself became more of a glorified casino than an actual exchange.

To draw a less gloomy conclusion and end on a more positive note, however, we would like to point out that in 2020 and beyond, it isn’t difficult to find legitimate trading partners in your quest of acquiring Chinese assets. While learning the ropes can be a bit difficult and while growing pains still exist in the financial services space when it comes to Chinese assets, it can most definitely be done and the potential rewards are high enough to justify the additional effort. Needless to say, the ChinaFund.com team is more than happy to assist you in your journey toward identifying the right companies to deal with. Simply visit our Contact section to send us a message with whichever concern(s) you have in mind and we will do our best to get back to you with a battle plan in a timely manner.

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