Derivatives house of the year, China: Shenwan Hongyuan Securities

Asia Risk Awards 2023

The Shenwan Hongyuan team

Chinese stocks have been on a downward trend since the beginning of last year, one that abated only briefly at the start of this year amid optimism around the country’s reopening. This has made for a challenging environment for Shenwan Hongyuan Securities (SWHYSC), the Chinese securities firm that boasts one of the country’s fastest growing equity derivatives businesses in recent years.

Demonstrating strong adaptability, SWHYSC has not only been able to weather the storm but also continues to grow its derivatives business, serving investors on both sides of China’s borders.

SWHYSC is one of only eight tier-one brokers in China’s over-the-counter equities derivatives market, which allows them the privilege of trading single-name options with qualified counterparts. As of March 2023, the company made up 10% of China’s OTC options market, in terms of outstanding contract value.

Yuanning He

“We retain our leadership in the OTC derivatives market, by providing some of the most sophisticated derivatives solutions to clients to help with their risk management and asset allocation needs,” says Yuanning He, head of trading, EQD at Shenwan Hongyuan Securities. “OTC derivatives continue to play pivotal roles in state-level strategy implementation and household wealth management.”

In its derivatives trading with banks overseas, SWHYSC is now also in the process of aligning itself with international standards and practices, by getting ready to start posting initial and variation margin on its non-cleared derivatives portfolios. This follows last year’s implementation of China’s Futures and Derivatives Law, which provided long-awaited clarity on close-out netting enforceability.

He says the implementation of the law has provided a solid foundation for the development of China’s OTC derivatives market in the years to come.

Shelter from the storm

In the past 12 months, the CSI 500 – one of the most tracked indices in China’s equities structured products market – dropped by more than 8%. SWHYSC reacted by revamping its product suite with the addition of new products to meet the needs of an increasingly cautious investor base.

“Amid market volatility, we proactively adjusted our product offering strategies to introduce more prudent structures to our wealth-management clients across the country,” says Nan Bai, head of sales, EQD at Shenwan Hongyuan Securities.

Nan Bai

In 2022, the firm has seen a year-on-year increase of 73% in principal protected note (PPN) issuance. Essentially, these products are based on zero coupon instruments sold with a premium on top, with the premium used to fund an options position linked to a fund or index. This enables investors to get some upside from the performance of the underlying asset while limiting their downside risk.

“We offer to clients various payoff structures to express their views, and preserve their wealth under different market conditions,” says Bai.

The most popular underlying index for structured products in China’s domestic market is the CSI 500 because there is a liquid futures market based on the index with a very favourable contango structure that allows firms to design products with attractive risk-reward profile, according to Bai.

Besides PPNs, snowball autocallables still attract attention – especially from private banking and retail investors – despite the sluggish performance of China’s equities market over the past 18 months. Some product structures have also evolved along with the changing dynamics of the market. The firm introduced a snowball variation called lifeboat snowballs, where the knockout level will be adjusted to a lower level if the product is knocked in.

QIS taking off

SWHYSC has also seen growing investor interest in its suite of quantitative investment strategies over the past 12 months.

“Based on our strong capital market know-hows and ability to orchestrate cross-border resources, SWHYSC’s proprietary QIS is attracting a lot of investors’ interests,” says Xiaoqing Zhang, head of cross-border trading, EQD.

The firm’s flagship proprietary quantitative investment strategy is the ‘SMART’ index – a global asset allocation index that is now tracked by roughly five billion yuans’ worth of asset management products.

Helped by the company’s dual listing in onshore China and in the offshore Hong Kong market, SWHYSC was able to enlist a foreign investment bank as a co-developer of the index.

Yanan Guo

The index has also been a popular choice as an options underlying in the PPNs that have received so much traction with SWHYSC’s in the past year.

“Principal protected notes remain the most popular way to track,” says Zhang. “With a volatility control mechanism, we are able to lower the volatility index to a very low level, say 3–5% per annum. That is a very favourable volatility figure to quote options on, due to a very cheap option premium.”

The SMART index linked-PPN speaks to risk-adverse investors that prioritise principal safety, adds Yanan Guo, SVP of sales, EQD at Shenwan Hongyuan Securities.

“As a turn-key solution to global asset allocation, the risk-reward profile of SMART index attracts many clients such as commercial banks and private banks,” says Guo. “Since [China] has not yet fully opened our capital account it’s rare to have a product wrapped in a principal-protected way that gives clients exposures to a broad range of asset classes globally.”