The Shanghai Hong Kong Stock Connect has acted as a major catalyst for the trading of derivatives products, including warrants and callable bull/bear contracts (CBBCs) linked to relevant H-shares, says Simon Yung, head of warrants and CBBCs sales at Standard Chartered in Hong Kong.
“The launch of Shanghai Hong Kong Stock Connect has so far brought about sheer size of transactions for both mainland and local stockmarket, adding to the liquidity of H-shares, especially financial institutions such as banks and insurers, security firms, which are set to benefit most from the recent A-share rally,” said Yung.
“That said, it also means these shares now become easier to hedge and potentially more shares could be used for the issuance of warrants and CBBCs, leading to more choices for investors beyond index-linked products, which, due to market volatility, took a beating last year regardless of bearish and bullish scenarios.”
The need to hedge for the creation of structured products had been seen by local bankers as a drawback to product creation, with the bankers expecting an active share market to lead to relaxed limits, after which the issuance of structured products based on H-shares in Hong Kong would naturally follow.
Yung anticipates increased sales of more and larger derivatives contracts, including structured products. “More shares have shown increases in implied volatility following the implementation of the Shanghai-Hong Kong Stock Connect, especially those of banks and security firms co-listed in Hong Kong and the mainland, and also exchange-traded-funds (ETFs) tracking A shares,” said Yung.
“The implication is that the market expects to see more volatility in the coming two to three months. Investors hence have more opportunity to stay defensive and profit from the CBBCs market as implied volatility pushes up option prices and the resulting lower leverage makes it less probable for knock out. ”
However, Yung stated that it is still too early for the introduction of A-shares warrants in Shanghai and Hong Kong. “It is less likely that A-share warrants would be released within two to three years, considering that the T+1 settlement rule has become the barrier for such development.”Yung attributed the recent trend of market players suspending trading of warrants and CBBCs in Hong Kong to investor tendencies to choose the same issuer and the expense of listing, which has created difficulties for late-comers.
“However, it does not mean the market could only be dominated by large firms,” he said. “According to the statistics for last year, products that gain profits were tier 2 or 3 shares rather than well-known brands, such as Hong Kong Exchange or Tencent. So, as long as the issuers could capture the potential shares, small firms could be competitive in this market.”According to the World Federation of Exchanges, Hong Kong is top in the trading of listed derivatives this year (until the end of November), recording volumes of $3,821bn from the trading of 6,610 products.
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