SRP China Awards: Shenwan Hongyuan capitalises on market transition

The full licence, handed out by the China Securities Regulatory Commission (CSRC) in December 2020, enables securities firms to conduct over-the-counter (OTC) derivative trading with any company qualified to trade equity derivatives while Tier 2 companies can only trade with Tier 1 companies.

Prior to that, Shenwan Hongyuan Securities (SWHY) was also granted a pilot scheme licence for cross-border business in July 2020, which paved the way for the use of offshore underlying assets.

“We achieved more than most tier-1 dealers operating as a tier-2 dealer until 2021. From 2018 to 2020, SWHY jumped from sixth to third to second in the league table of OTC options notional outstanding [made by CSRC],” Tang Jun (pictured), member of executive committee and head of equity derivatives at SHWY told SRP. 

In 2021, the firm completed 9,144 OTC option trades with a notional amounting to CNY649.2 billion (US$100 billion), which was up 42.1% year-on-year, or nearly the triple compared with 2019.

During the same period, SWHY issued a total 1,043 retail structured notes, known as “beneficiary certificates (收益凭证)”, with a combined notional of CNY33 billion in China, which translated into a 147% increase year-on-year. 

“Following the debut of exotic option embedded products like CSI 500-liked snowball autocallable notes, they soon became a door crasher across all distribution channels, especially among retail investors and onshore private banks,” Tang said.

Subsequently the securities house launched index enhancement notes and bullish notes linked to the CSI 500 offering full capital protection. “The SWHY-Voyage series of CSI 500 bullish note immediately became our flagship principal-protected product after its debut in April 2021,” said Tang.

The one-year note had a 110% participation rate with the payoff deployed through a fixed-coupon bond and a CSI 500 vanilla call.

“It offered a worry-free way for the risk averse investors to participate in the mid-cap equity market,” he said.

The launch resulted from a surging demand for snowball autocallable products linked to the CSI 500 at the beginning of 2021, with investors selling exotic CSI 500 put options and trading desks taking on large CSI 500 volatility positions, reaching risk limits on Greeks.

“The trading desk naturally sought to balance its volatilities positions by pricing the CSI 500 vanilla structure, which was a volatility short. The 12-month CSI 500 index call option was priced at an almost 40% discount where the premium could now be covered by the 12-month bond,” said Tang.

The SWHY-Voyage series was issued twice a week and raised a total notional of more than CNY300m as of December 2021.

Transformation

The structured product market in China has been heavily shaped by regulatory action over the past four years. In 2018, the landmark asset management regulations were released with a one-year grace period to break the “rigid redemption (刚兑)” by adopting the net-asset-value (NAV) model for wealth management products (WMPs), under which WMPs are valuated mark-to-market and shall no longer guarantee an expected return in an explicit or implicit way. 

“Over the past two years, we’ve seen onshore investors increase their allocation of equity securities while gradually lowering that of real estate or fixed income securities. The shift brings great opportunities for equity derivatives and equity-linked structured products,” said Tang.

The former Société Générale trader and his team have been working to provide a more diverse product shelf in the current high volatility environment as a derivative manufacturer serving banks and asset managers. “Structured products can play a critical role in such market based on my experience at foreign investment banks, such as by providing more choices with non-linear payoffs,” he said.

The wealth market transition is full of challenges and requires the collaboration of market players. WMP issuers now face the pressure of dealing with the NAV decline and are keen to find out how structured products can leverage the volatility, especially through innovative structures that can be effectively hedged.  

In the meantime, the market is testing the risk management capabilities of securities firms - whether they can effectively price the liquidity and volatility.

One example is the concentration risk that a securities house may face when conducting a large-scale single transaction with a corporate client. “In this case the solutions are expected to be very detailed,” he said. “We need to consider whether the client bears any downside risk and whether the return is capped besides the pricing of taxes and dividends.”

Additionally, multi-asset allocation indices are a key focus at SWHY. The SPDB Global ESG Index, which was co-developed by Shanghai Pudong Development Bank, SWHY and a foreign investment bank, went live in October 2021 and features as the underlying of structured deposits.

Two months later, the broker launched its proprietary SWHY Multi-Asset Rotation Tactics (SMART) Index, which has collected CNY500m notional through structured notes sold to retail investors since its launch.

The pricing of such products requires more than a single-series model as they cover global cross-asset classes. Hence various correlation risks need to be managed, according to Tang. In the past, the pricing model used by SWHY applied to regular single-asset capitalisation-weighted indices, such as the CSI 300 and CSI 500. 

“This process also involves how to simulate and manage risk exposure across different types of markets, so that the product ultimately helps clients reduce risk dependence on a single asset or a single market, which means that we had to shift to stochastic volatility models from traditional local volatility models,” said Tang.

The introduction of the SMART index is part of the SWHY strategy to include offshore underlying assets in its offering after obtaining the pilot scheme license in July 2020.

“We aim to better serve offshore investors’ needs for onshore assets allocation,” said Tang. “Despite the recent volatility hikes seen in the A-share market, I believe onshore equity represents a trend from a long-term point of view and will become crucial to global asset allocation.”

Tang also noted that WMP issuers prefer taking a moderate approach in response to the transition.

“At this time, we aim to provide solutions with an acceptable risk level that helps the industry with the transition as a hedge provider,” he said.

“As a result, we need an expanded team to improve our risk management capabilities while meeting regulatory requirements and promoting our brand,” said Tang. “This will be very important for us this year.”

The broker will also focus on the needs of institutional investors, especially around corporate clients which have demand for risk management, asset allocation, wealth preservation and appreciation.

Diversity 

China’s capital market has been opening up in the past five years with many Chinese companies listing in the US and Hong Kong SAR. In the meantime, the demand for onshore treasury, equity and commodity exposure is rising among offshore investors, according to Tang.

“In contrast to the declined interest rates in overseas markets, the onshore interest rates remain above 3% overall, which provides a relatively easy environment [for structured products],” he said. “From the perspective of diverse asset allocation or yield enhancement, the demand from Chinese investors remains very strong, although many investors turn risk-averse in the current volatile market.”

Although the structured product market in China is dominated by onshore capitalisation-weighted indices, there’s demand for Hong Kong stocks via the Hang Seng China Enterprises Index (HSCEI) as well as for Chinese stocks listed in the US, the S&P 500 and European stocks, according to Tang.

“In the context of the current global market volatility and geopolitical instability, principal-protected notes have been gaining traction,” said Tang. “Recently, we’re seeing the market slightly stabilised, and may launch new strategies with no capital protection, such as autocallable and phoenix notes.”    

Tang is also the winner of the Personality of the Year at the SRP China 2021 Awards. Click the link to read more.