Mainland China’s two stock exchanges, Shanghai and Shenzhen, widened the list of stocks available for securities borrowing and lending (SBL) at the end of 2016. Over 70 new securities were opened up to lending, bringing the total number across the two bourses to 950.
Both bourses now link to Hong Kong through separate Stock Connect initiatives, creating an approved solution for lenders and borrowers of Chinese A-shares. Even so, SBL activity remains very subdued and it is considered uneconomic to trade.
“Securities lending is at a very early stage in China but as the market matures I am sure that it will become much more interesting,” says Rakesh Patel, head of equities, Asia-Pacific, HSBC.
Last year’s decision by MSCI to keep mainland-listed shares out of its key emerging markets index was a blow to China’s regulators. Another review is expected in June and a green light would be viewed by many as a positive step for SBL activity.
However, MSCI’s snub proved to be an opportunity for certain firms. In February, BBH analysts noted an uptick in demand to borrow Deutsche X-trackers Harvest CSI 300 China A-Shares ETF (ASHR) following the index provider’s decision. ASHR tracks the CSI 300 Index and offers direct access to Chinese A-Shares. BBHs expect ETFs in general to remain in demand, specifically ASHR.
Hong Kong-listed Chinese property stocks, which proved too hot for short sellers in early 2016, saw a jump in shorting activity mid-2016 as high investor demand drove prime urban real estate prices higher.
There’s evidence to suggest margin financing and securities lending balances are continuing to grow domestically; balances exceeded RMB1.1trn in 2015, according to KPMG statistics. However, regulations do not currently permit offshore participants to engage directly.
In addition, extreme stock market volatility two years ago means the Chinese Securities Regulatory Commission’s (CSRC) focus has shifted away from continuing liberalisation of markets towards stabilisation. This approach has extended to securities finance.
“China will want to move at its own pace when liberalising capital markets – they will not be forced into running at anyone else’s pace,” says HSBC’s Patel. “ They will have a very thoughtful and systematic approach to securities lending alongside the general evolution of the capital markets. It will take time but I think there is a growing appreciation of what securities lending can offer the market – liquidity provision, encouraging domestic flows and encouraging multi-asset strategies.
“There is no doubt that China will be one of the biggest lending markets globally. I am sure about that. But it will not happen in the short term.”
Davin Cheung, global funding and financing sales, APAC, Clearstream Banking says that the prospect of tri-party in China is “quite exciting”, given it is the third biggest bond market in the world and there are thriving OTC and exchange markets for cash and bond repos, plus a growing stock loan market.
“The market for the moment is quite domestic, but we recently opened a link into China (CIBM) whereby our international clients could basically buy-and-hold those China bonds and safekeep them in Clearstream. We have initiatives and MOUs with multiple infrastructures such as CSDs to share ideas in terms of, for example, how to mobilise and internationalise those assets and to further create collateral value from these assets for market players.”
Issues to consider include how quickly bonds would be turned over and, from the regulator’s point of view, whether a withholding tax would be required. “Major CSDs in China already have the knowhow and systems and they are just waiting for the green light to jump start tri-party offerings in China,” says Cheung.
Some participants in China fear the exchange rate and repo market is growing too big. New issues can be repo-ed immediately, which leaves the exchange holding market risk. “Obviously, based on international experience, products such as tri-party could mitigate market and credit risk if we look further into how the collateral is to be mobilised, eligibility criteria and the imposition of appropriate haircuts,” adds Cheung.
Looking at China’s economy more broadly, there are increasing signs of corporate earnings and profitability improving. “With growth on track, policy has shifted towards a focus on risk control (e.g. the property market, leverage, non-performing loans (NPLs), and capital outflows). The government will likely also focus on tax reduction and state-owned enterprises (SOE) mixedownership reform. Southbound flows could cushion the downside risk for MSCI China amid higher RMB volatility, although higher US rates tend to dampen EM inflows,” HSBC analysts said in an investment outlook in February.
“We think China’s structural economic challenges remain largely unsolved. Policymakers also face the dilemma between curbing the risk of property bubbles in selected cities while supporting the property sector as a key growth stabiliser.”
ICBC Standard Bank: Expect eye on repo
China is a huge financial market and home to some of the largest credit institutions in the world, with future developments that are set to open up the financing market even further. Noticeably, many Chinese onshore assets are utilised in repo transactions, conducted out of Hong Kong and other neighbouring jurisdictions.
At present, the legal opinion for repo conducted within China is not clear, which means that bespoke legal advice is required prior to entering into global master repurchase agreements (GMRA) with domestic players.
Iain Colquhoun, Head of Corporate & Bank Flow Sales, ICBC Standard Bank, comments: “The Chinese market shows enormous potential but it is clear that a good deal of this potential is currently restricted from global participation. At ICBC Standard Bank we are able to provide a good link into the mainland and welcome discussions with international participants who may look to deploy resources in this area.”