Jan 29, 2023
Investors Call for More Tools to Hedge China Market Risks
(Bloomberg) -- Four years after Chinese stocks were included in benchmark global indexes, a tumultuous time in Chinese markets has underscored the need for a broader set of ways to guard against risk.
Futures, for example, are only available on 50 of the most liquid stocks out of almost 3,000 listed shares in China. Securities lending is also banned, blocking shorting of shares on the trading link between Hong Kong and the Chinese mainland.
“If you can’t fully risk manage your trading exposure in the market, that raises the cost of trading,” said Eugene Goyne, the financial regulatory lead for Asia-Pacific at Ernst & Young. “There’s still a material disincentive to dealing in the China market.”
China is keen to attract foreign capital to its $10 trillion market, but also wary of its impact. Over the past years it has relaxed foreign quotas and set up trading links for stocks, bonds, exchange-traded funds and will soon also link up its interest rate swap market. But officials have said they keep a close eye on fast money that can create large swings. Fresh in memory is a market tumble in 2015 that resulted in more than 1,400 listed companies suspending trading, months of stock and currency interventions, and investigations to root out short sellers.
China’s benchmark CSI 300 index has risen 22% from a low in October.
Lyndon Chao, managing director of equities and post trade at the Asia Securities Industry & Financial Markets Association, said an expansion of hedging tools, including securities lending, would be key to broadening the appeal of China’s A share market to global institutional investors.
“Players now in the A share market are mostly long-only passive index funds and some quantitative funds,” he said. “If you would open it up for securities lending, you can attract more active managers including market neutral hedge funds, who can add significant liquidity to the market. But they will need access to a vibrant securities lending and borrowing environment.”
Foreign investors still make a up small part of the market, holding about 4.7% of China’s stocks, according to data from the People’s Bank of China.
The MSCI Inc. back in 2019 listed four conditions to further deepen inclusion of Chinese shares. Some of those have been met, including an omnibus trading arrangement to allow a single order placed on behalf of multiple clients. The exchanges have also smoothed out a mismatch in holidays between the two markets, which had shut off trading for about a month each year.
Another breakthrough happened last year when MSCI launched its A50 futures on Hong Kong Exchanges & Clearing Ltd., competing with Chinese stock futures trading in Singapore. So far, Singapore’s futures remain dominant.
“It needs time to build liquidity,” said Wilfred Yiu, co-chief operating officer of the Hong Kong exchange, last week. “We are here to provide the right suite of products and make sure there is abundant liquidity to facilitate trading.”
Other products are also in the pipeline, including Swap Connect, which, when in place, will link Hong Kong and international investors with China’s interest rate swap market.
Separately, more Chinese government bond futures are also expected after China offered support in September, adding another potential hedging tool. International holdings of Chinese bonds rose to 4.1 trillion yuan as of December 2021, up from 900 billion yuan in June 2017, according to HKEX data.
Other structural issues that are seen to need a fixed for a meaningful push for the cross-border schemes:
- To allow block trades in Stock Connect and ETF Connect
- To raise, or remove, the 30% cap on foreign ownership of single stocks
- Enhancing order amendments to make it easier to correct a passive trade order in a volatile market rather than having to cancel the order altogether
“All of that inhibits a degree of liquidity within the market,” said Goyne. “Adding those all up, the accumulative effect is substantial.”
Hong Kong’s new market regulator head, Julia Leung, offered investors some hope this month, saying there will be more hedging products to cover China this year.
HK to Launch More Risk Management Products This Year: SFC CEO
Whether there will be meaningful progress this year is still up for debate. Some are counting on post-Covid boost to enlarge market access, in particular to a new program that links up Hong Kong wealth management with southern cities in China.
“In the past few years, we got bogged down by the Covid policy,” said said Sally Wong, chief executive officer of the Hong Kong Investment Fund Association, which represents firms with more than $52 trillion in assets under management. “Now with the re-opening, we need to reset.”
Still, broader progress will rely on regulators in Beijing.
“A degree of patience is realistic,” Goyne said. “It may not meet foreign market expectations. But you are dealing with a sizable capital market that has its own domestic agenda and transition issues that need to be addressed.”
(Adds market gain in fifth paragraph. An earlier version corrected spelling of company name in third paragraph.)
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