‘Synthetic’ Basket Opens Avenue to Bet Against Chinese Stocks

Several American financial companies are devising customized products to circumvent regulations and short Chinese stocks, as coronavirus fears continue to roil the markets.

Although costs tend to be prohibitive when looking to bet against China’s enormous equity market, researchers have packaged up around 40 US stocks that are heavily exposed to the Chinese market, in a product that reflects the CSI 300 benchmark. The index has an overall market capitalization topping $4.5tn.

London firm Quant Insight calculated the cost of lending Chinese stocks for short selling can cost more than 10 percent of the equities’ yearly value, whereas a custom solution can cost around 2 percent.

Goldman Sachs has also included the index in its online offering, allowing clients to buy derivatives which are classed as total return swaps.

Mahmood Noorani, the head of Quant Insight, said Chinese equities are “eye-wateringly expensive” to short directly. The solution addresses “a clear pain point” for global investors, he told media.

There are clear advantages for both investors wanting to make more detailed or specialist bets, and the banks who will earn higher fees for offering such tailored products.

Hedge funds wanting to bet on Italy’s economic fate, but without exposing themselves to the Milan stock market’s US exposure, a bespoke, “synthetic” product would allow them that opportunity.

The Chinese equities market is attracting increasing investor attention due to its further integration into global indices and its increasing size, along with the impact of the coronavirus, which has sent China’s market, along with several others, into freefall.

Since January, the CSI has taken a kicking and plummeted about 5 percent.

“The virus will probably result in a big hit to China’s economy in the first quarter, and the longer it goes on, the more likely it is to have knock-on effects to the global supply chain,” said Evan Brown, head of multi-asset strategy at UBS Asset Management.

Asset managers have long lobbied for Beijing to make it easier to short domestic stocks, as they see it as a crucial component of a modern, efficient market by allowing investors to also protect their holdings against falls, something known as hedging.

Short selling is legal in China, but Beijing restricted stock lending to only the biggest companies in 2015 after a bout of market turbulence that the authorities said was exacerbated by those placing negative bets.

Investors can also short the entire market using futures, but this too can be costly given investors have to “roll” into new futures contracts once the old ones expire. “There are often structural impediments in capital markets, but this product solves an issue,” said Nicholas Gelber, a managing director at Goldman Sachs’ synthetic products desk. “There are other ways to express a view on China, but it comes down to all-in costs.”