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Individual Chinese investors who banked on calm market conditions by piling money into derivatives have suffered heavy losses, further eroding confidence in the country’s struggling stock market.
The so-called snowball market, which promises large interest payments as long as stock indexes trade within a certain range, has grown into an estimated 320 billion renminbi (approximately 4.5 trillion yen) market in China.
Brokers and personal wealth management firms spent 2021 touting the higher yields offered by these derivatives (so named for their ability to accumulate steady returns for their holders) during a period of relative calm in the stock market. Increased sales.
However, a prolonged decline in stock prices starting in the second half of 2023 will cause the index to break through the lower bound built into the contract, causing a so-called knock-in, meaning that many holders will face large losses on their original investments unless stock prices recover. became.
Most of the estimated RMB 327.5 billion outstanding issuance is related to the CSI 500 index of Shanghai and Shenzhen listed stocks and its small-cap equivalent CSI 1000 index, said Zhao Wei, an analyst at Sinolink Securities. ing.
Mr Zhao said a snowballing “wave” had “washed up” this week when some Chinese stocks fell to five-year lows. Markets have stabilized since then, with Chinese Premier Li Qiang pledging “strong” state support to stem the decline.
Retail investors are currently facing large losses on investments that were marketed as a relatively safe alternative to bank deposits.
“Sales teams start marketing to clients by asking them the following question: Do you think the CSI 500 can fall by more than 20%? If not, do you think you should buy a snowball as a safety net? Yes,” said the head of a mid-sized Chinese brokerage firm that sells snowmen.
Stephanie Liu, a 34-year-old office worker in Shanghai, banded together with friends to buy a snowman worth RMB 1 million in June 2022. The contract was to earn a 15% yield over two years, as long as the CSI500 did not fall any further. It goes up by 20 percent or more than 3 percent.
Her contract has now reached the “knock-in” threshold, meaning she will lose 20 percent of her original capital unless the market recovers significantly by June.
“I feel helpless and guilty. [because of] Friend,” she said. “It’s a situation with no resolution. It’s not the right question to ask why it snowballed and it’s not the right question to ask why the index is performing like this.”
Despite their small size compared to the overall Chinese stock market, analysts said the wipeout of some snowball holders could make the collapse in Chinese stocks even worse. Brokerage firms that sell contracts typically buy stock futures to hedge their positions. When a knock-in is triggered, those hedges must be sold.
“If the market is in a downturn and futures trades are linked to snowballing positions, selling pressure on Chinese stocks could increase,” said Yu Mingmin, an analyst at brokerage firm Cinda Securities. said.
In 2021, the China Securities Regulatory Commission asked brokers to strengthen risk management of snowball bonds and refrain from selling them as bond products. Nevertheless, regulation in this area remains relatively lax.
CSRC did not immediately respond to a request for comment.
Complex derivatives in products such as Snowball have backfired for Asian investors before.
In 2009, several major banks suffered significant losses after a South Korean court exempted hundreds of companies from contracts that could be ruinous if the won moved outside a set range.
Korean retail investors’ interest in so-called autocall stocks has also been blamed for hurting European stocks and reducing volatility in U.S. stocks.
Additional reporting in New York by Jennifer Hughes