SBL

Securities borrowing and lending (SBL) of Chinese A-Shares has been available through the Shanghai- Hong Kong Stock Connect since 2 March 2015. 

Hong Kong and overseas investors cannot participate in the Margin Trading and Securities Lending Programme provided by Shanghai Stock Exchange in mainland China. 

Participants must be exchange participants or designated as a qualified institution, which includes firms that are registered to take part in asset management (type 9) activities. 

SBL for covered short selling and for meeting the pre-trade checking requirements in certain circumstances is permitted through the Shanghai- Hong Kong Stock Connect. SBL agreements for covered short selling purposes cannot be longer than one month. SBL for pre-trade checking purposes cannot be longer than one day. 

Only a limited list of eligible short selling securities can be short sold, which is published on the Hong Kong Exchange (HKEx) website. Securities are subject to a short-selling quantity restriction, which amounts to a 1% daily limit and a 5% cumulative limit over ten trading days. The daily limit usage will be calculated in real time throughout the trading day. 

Mandatory reporting requirements for short selling activities must be submitted to the HKEx including a weekly report detailing any short selling activity and a large open short position report, which is completed for any trade above RMB25m ($3.8m) or 0.02% of the total issued shares of the relevant security.

After the recent volatility in Chinese markets, the regulatory momentum that drove the creation of the SBL model has waned, according to a report by BBH’s head of global securities lending trading for Asia Pacific, Zubair Nizami. The Chinese Regulatory Securities Commission’s (CSRC) focus has shifted away from continuing liberalisation towards stabilising the market. 

“Over the long term, however, we are optimistic that the CSRC will look to introduce reforms to the offshore securities lending market,” he says. “The CSRC has historically taken a structured and measured approach to market liberalisation. As offshore holdings of A-Share securities grow, the ability of lending to improve market liquidity and allow investors to manage risk will align with the CSRC’s broader objectives for market stability.” 

As overseas institutions increase their A-Share holdings and when China’s regulatory priorities shift back towards liberalisation, BBH expects a scalable offshore lending model may emerge in the next two years. 

Synthetics

Equity index swaps, equity index futures, China A-Share Access Products (CAAPs) and participatory notes (P-notes) are widely used to gain exposure to the Chinese market, according to Deutsche Asset and Wealth Management. 

Some brokerages have made CNY-denominated class-A shares owned by clients through Shanghai Connect available for synthetic short sales, according to reports by Bloomberg, although a lack of available stocks that can be used in synthetic shorting has minimised usage. 

Additionally, it reports that some banks are scaling back synthetic shorts through Hong Kong’s stock exchange link with Shanghai, as a result of China’s regulators clamping down on short selling practices. 

International investors can also take short positions on China stocks indirectly through index futures traded in the country such as the Singapore-listed FTSE China 50 index futures or Hong Kong-traded iShares FTSE A50 China Index ETF. 

Repo 

The Chinese repo market has been open and active for several years, but until recently could only be accessed onshore. In 2015 regulation relaxed to allow offshore RMB clearing banks, approved offshore participating banks, foreign central banks and sovereign wealth funds to participate in the onshore CNY repo markets. 

This formed a wider set of changes to bring together forward, interest rate swap and bond lending transaction regulations. Participants had to complete registration with the PBOC and sign the NAFMii, the local unilateral repo master agreement. However the PBOC have since restricted onshore bank’s lending to offshore, so progress has been stilted. 

The market is in the form of pledge rather than outright legal transfer, which is the internationally-used form of repo. Banks put all deals through a People’s Bank of China (PBOC) platform called China Foreign Exchange Trade System (CFETS). There is also the Shanghai Bond Collateral Repo system, which is used by individuals and non-bank institutional investors. 

“There was initially a lot of excitement about the market opening up but the restrictions put in place by the PBOC, the limitations of the market structure and a lack of willingness of Chinese banks to lend CNY to offshore investors means any growth in the near future will be stilted,” says Ed Donald, global head of repo at Standard Chartered. “But long term I believe the Chinese repo market will develop and open up further.” 

“Many international participants are not familiar with the Chinese repo rules, infrastructure or the legal agreement, which has to be signed in Chinese. Because it’s a pledge market, it will always have its limitations from an international perspective. You cannot rehypothecate the collateral nor freely trade the currency and there is also no concept of netting.”

Nonetheless, firms are very keen to participate in the Chinese securities finance market as it opens up, according to Sinopac Securities’ head of SBL, Thomas Lui. China has got the potential to be an incredibly important market in the future. However, with volatility slowing down the pace of development and the regulators understandably cautious, it isn’t certain that the market is going to take any more significant steps to liberalise any time soon.