Chinese officials plan to ban online brokers from providing offshore trading services to mainland clients. The action falls within the framework of a widespread regulatory crackdown, prevalent in various sectors of China's economy this year.

China announces crackdown on online brokers

Consequently, the restrictions will prevent millions of retail investors in mainland China from trading securities in US and Hong Kong markets. According to available data, the reason for the ban was growing concerns about data security and capital flight.

The coming restrictions will be the next step in a series of tough measures that have affected a wide range of companies in sectors ranging from technology to education and real estate over the past year.

According to one of the four anonymous sources, businesses affected by the latest crackdown will likely be notified of the ban in the near future. (all sources declined to give their names as they were not authorized to speak to the media).

Some Chinese companies, such as Futu Holdings Ltd and UP Fintech Holding Ltd, are listed on the Nasdaq and are the Pacific region's biggest players in the sector.

Thus, Futu and UP Fintech are listed by the Securities and Futures Commission in Hong Kong. However, this permission does not apply to the mainland. Sources said that there are no licenses in the mainland market for online brokerage companies specializing in cross-border transactions.

Futu, which has an estimated market value of $5.5 billion, has already stated that it has communicated with Chinese authorities but has not received any formal notices or instructions. Company officials added that the offices were operating in a standard mode.

However, the company's prospectus for the April share issue noted that its business could be affected by a change in stance from the authorities, who have broad discretion in interpreting regulations.

UP Fintech, valued at $737 million, said it has followed the rules set by global regulators and will comply with and implement any new regulations.

Futu stocks recently rose by 1.5%, while UP Fintech shares lost about 2%. Shares of both companies fell at the premarket.

The China Securities Regulatory Commission (CSRC), the State Administration of Foreign Exchange (SAFE) and the central bank did not immediately respond to a request for comment.

Chinese authorities raised concerns about cross-border brokerage services in October, exacerbating the drop in both companies' stocks, which have plunged more than 80% since this year's peak in February.

PRC authorities have harassed a wide range of sectors over the past year. Moreover, data security has become a major concern.

In October, the official People's Daily warned that the vast amounts of information collected by these brokerage agencies could be at risk if the data were required by authorities such as the US Securities and Exchange Commission.

According to three resources, authorities are also concerned about capital outflows and worry that the fast-growing businesses of these firms could disrupt China's currency control agenda.

Two sources said that Futu executives have lobbied authorities including the CSRC, SAFE and the central bank, however they have received no positive feedback so far.

They believe the ban would affect a significant portion of the business of companies like Futu. For example, about 40% of Futu's customers open their trading accounts with Chinese IDs. The majority of other accounts were opened by traders who have US, Singapore and Hong Kong IDs.

Backed by gaming and social media giant Tencent Holdings, Futu had 2.6 million customers who had opened one or more trading accounts at the end of September.

Futu's trading turnover rose to HK$1.4 trillion ($179 billion) in July-September from HK$1.01 trillion in the same period a year ago, with more than 90% of that volume coming from trading in US and Hong Kong stocks.

According to one source, individuals can still open new accounts with Futu using mainland Chinese identification cards. However, currently the company insists that these clients have foreign bank accounts.

Apart from the services offered by brokerage firms such as Futu and UP Fintech, mainland investors can only invest in securities outside China through so-called Qualified Domestic Institutional Investors (QDII) schemes, and connection schemes that link the Hong Kong and mainland stock markets. Both of these schemes are heavily regulated and have a high percentage of government intervention.

Obviously, the news will make traders wary of trading on the mainland. Besides, the sector as a whole could experience a shock that will affect Hong Kong exchange volumes. It would accelerate volatility in the markets together with the unstable real estate sector.