China’s relentless stock market rout is putting pressure on $13 billion worth of snowball derivatives, threatening to raise market volatility as brokerages are pushed to liquidate hedge positions.
About 30 billion yuan ($4.2 billion) of those structured products tied to the CSI 1000 Index are near levels that trigger losses at maturity, according to Guotai Junan Futures Co.Another 60 billion yuan of the derivatives are 5%-10% away from their knock-in thresholds, the brokerage said.
Snowballs promise bond-like coupons as long as the underlying assets trade within a certain range. While that has attracted China’s institutional and wealthy investors over the past years, a seemingly bottomless decline in the stock market has exposed the risk of those derivatives hitting levels that trigger losses.
The equity slump continuing into 2024 has set off concerns over risks stemming from such securities. Brokerages hold on to index futures to hedge the exposure that comes with selling snowballs, and the triggering of knock-in levels by some of them has been behind the closing of long positions in equity futures, wrote Guotai analysts including Yu Kan.
China’s CSI 300 benchmark has fallen about 4% thus far in 2024, extending last year’s 11% slide. The CSI 500 and CSI 1000 indexes, which snowballs are mostly tied to, closed at their lowest levels since April 2020 and April 2022, respectively, on Wednesday.
Similar to autocallables in other markets, a snowball investor loses money if the underlying index falls below a pre-determined level and does not bounce back. The derivatives have grown into a market worth $27 billion in China, though regulators have tightened their grip to prevent them from being marketed to retail investors as fixed-income products.
Losses from structured notes tied to Chinese stocks have also become an issue in South Korea, where the regulator is intensifying a crackdown into potential malpractices by brokers.
While an extremely bearish scenario of 200 billion yuan of snowballs hitting knock-in levels within a week would trigger a selloff in futures, that would equal to about 2% of an average week’s turnover, CICC said. Still, the episode could deepen the pessimism in the market, the broker warned.
Bearish sentiment prevails as market watchers see few catalyst for China stocks. Economic data continue to point to a weak economic recovery, while geopolitical tensions simmer and policy roadmap remains unclear. The market’s weakness has also been attributed to selling and redemption pressures by mutual funds.
About 30 billion yuan ($4.2 billion) of those structured products tied to the CSI 1000 Index are near levels that trigger losses at maturity, according to Guotai Junan Futures Co.Another 60 billion yuan of the derivatives are 5%-10% away from their knock-in thresholds, the brokerage said.
Snowballs promise bond-like coupons as long as the underlying assets trade within a certain range. While that has attracted China’s institutional and wealthy investors over the past years, a seemingly bottomless decline in the stock market has exposed the risk of those derivatives hitting levels that trigger losses.
The equity slump continuing into 2024 has set off concerns over risks stemming from such securities. Brokerages hold on to index futures to hedge the exposure that comes with selling snowballs, and the triggering of knock-in levels by some of them has been behind the closing of long positions in equity futures, wrote Guotai analysts including Yu Kan.
China’s CSI 300 benchmark has fallen about 4% thus far in 2024, extending last year’s 11% slide. The CSI 500 and CSI 1000 indexes, which snowballs are mostly tied to, closed at their lowest levels since April 2020 and April 2022, respectively, on Wednesday.
Similar to autocallables in other markets, a snowball investor loses money if the underlying index falls below a pre-determined level and does not bounce back. The derivatives have grown into a market worth $27 billion in China, though regulators have tightened their grip to prevent them from being marketed to retail investors as fixed-income products.
Losses from structured notes tied to Chinese stocks have also become an issue in South Korea, where the regulator is intensifying a crackdown into potential malpractices by brokers.
While an extremely bearish scenario of 200 billion yuan of snowballs hitting knock-in levels within a week would trigger a selloff in futures, that would equal to about 2% of an average week’s turnover, CICC said. Still, the episode could deepen the pessimism in the market, the broker warned.
Bearish sentiment prevails as market watchers see few catalyst for China stocks. Economic data continue to point to a weak economic recovery, while geopolitical tensions simmer and policy roadmap remains unclear. The market’s weakness has also been attributed to selling and redemption pressures by mutual funds.