The chairman of China’s securities watchdog on Saturday said domestic mutual fund houses should have stronger risk controls, argued for tighter regulation of private fund managers and acknowledged flaws in its regulation of the equity market last year. 

Xiao Gang also highlighted plans to further increase its cross-border investment quotas, expand the scope of cross-border trading links and push for inclusion of A-shares in global indices.

In a speech at the annual internal meeting of the China Securities Regulatory Commission, Xiao said some mutual fund firms had not properly assessed risk when they bought big into stocks on the ChiNext board, Shenzhen’s tech-heavy, Nasdaq-style market. This increased risk both for themselves and for the whole market, in particular liquidity risk, he noted.

The CSRC's latest stress test shows how mutual funds' liquidity risk could spill over and cause a domino effect, Xiao added, noting that fund houses must establish sound risk control systems and limit investment leverage.

The CSRC had already reportedly warned fund managers to reduce their exposure to ChiNext shares last May amid ‘bubble’ fears at the time. The ChiNext board index saw explosive growth in the first half, reaching an all-time high of 4,037 points on June 3, up 163% from the end of 2014, but then fell 54% in the following three months.

Xiao also stressed the importance of tighter regulation of the mainland private fund industry. This appeared to confirm the CSRC's stance after media reported last week that the watchdog had suspended new registrations of private fund managers. 

Many private fund firms are weak in legal and compliance aspects, Xiao noted. For example, some have launched products that invest in public markets and provide capital guarantees, and certain players have been involved in illegal fundraising and have disappeared after investments have failed. He said the CSRC would further strengthen regulation and punish private managers violating the rules.

China's private fund industry has 25,000 registered managers with Rmb5.1 trillion under management but has lacked regulation for some time, noted Red Pulse, a Shanghai-based research firm. 

On Friday (January 15), the CSRC said it investigated more than 140 private fund managers and distributors last year. And it had administered “administrative punishments” to more than 27 private fund firms, such as Shanghai-based firms VStone Capital and Gopher Asset Management (part of wealth manager Noah Holdings). While the watchdog did not give details of the punishments, such penalties usually entail banning new business for a certain period.

In an unusual move, Xiao also acknowledged the CSRC’s flaws in stock market regulation. The market’s extreme volatility reflected an “immature equity market and participants, an inadequate trading and market system and an inappropriate regulatory system”. He added that the CSRC must learn a lesson from this. He made no specific mention of the index circuit-breaker that was launched this year but suspended after a few days, as reported.

Looking ahead to reforms in 2016, Xiao highlighted the CSRC’s plan to expand several cross-border investment schemes. This included further increasing quota for the qualified foreign institutional investor (QFII) and renminbi-QFII programmes, as well as pushing for China A-shares to be included in global benchmarks to attract long-term investments from foreign institutions.

The regulator is also prioritising starting the Shenzhen-Hong Kong Stock Connect, improving the Shanghai trading link and studying the possibility of a Shanghai-London scheme. The latter was first mooted as a possibility by the CSRC last September.