China Brokers Seen Joining $2 Trillion Structured-Product Market

China is preparing to let local brokerages sell structured products for the first time, allowing them to benefit from surging demand for complex investments tied to equities, currencies and other assets, according to lawyers involved in the market.

The Securities Association of China said in December it won regulatory approval for a trial over-the-counter trading program for products designed by local securities companies. The pilot program will allow China’s securities companies to create structured instruments using embedded options to enhance returns by giving them access to derivatives trading, from which they’d been previously excluded, according to lawyers at Linklaters LLP, a London-based law firm.

Commercial banks currently dominate the market for structured investments with their offerings of so-called wealth management products, said Chin-Chong Liew, Linklaters’ Hong Kong-based head of derivatives and structured products for Asia excluding Japan. Fitch Ratings estimates that more than $2 trillion has been invested in such products.

“In the securities world, I think it’s starting,” said Liew, who has advised Chinese companies on development of derivatives and structured products since 1995. The regulators “want to promote innovations, promote financial derivatives, promote structured products among securities companies.”

Under the trial approved by the China Securities Regulatory Commission, seven firms can issue and trade products that match their clients’ risk tolerance levels, according to a statement posted on the association’s website, which didn’t elaborate further on the types of investments that can be offered. The investments will range from “easy to hard,” it said.

‘Easy to Hard’

Haitong Securities Co., one of the participating brokerages, has introduced six funds with maturities of 14 days to a year for both individual and institutional investors to invest in low-risk assets including stock index futures. The prospectuses for the products, which were created for the trial, say that while they’re designed to generate returns of 4 percent to 7 percent, investors may also take losses.

Products traded in the market will gradually evolve into more complicated ones that are likely to use derivatives, Yin Xiusheng, vice president at Guotai Junan Securities Co., was quoted as saying Jan. 23 by the Shanghai Securities News. The company is also among the participants in the program.

“So far, securities companies have been quite constrained by their limited scope of business,” Jian Fang, a Shanghai-based partner at Linklaters, said by phone. “This could be their first step to get into the derivatives market.”

The OTC trading, starting with bilateral agreements, may eventually be expanded to include structured notes, or debt securities packaged with options to sweeten terms, Liew said.

“You can potentially in this platform issue structured notes,” he said.

Wealth Management Products

Brokerages’ entry into the structured-product market may further fuel the industry’s growth. In a December report, Fitch estimated that the amount of outstanding wealth management products issued by Chinese banks may have surged to 13 trillion yuan ($2 trillion) by the end of 2012 from 8.5 trillion yuan a year earlier.

Wealth management products, overseen by the country’s banking regulator, are linked to investments including equities, currencies and credit to generate higher yields similarly to structured notes, Liew said. More disclosures may be needed for the products as many are linked to assets described as “others,” he said.

“You don’t even know what they’re linked to,” Liew said. “People are chasing yields. In the last four years, the rest of the world came down, but China went up.”

Beijing-based Huaxia Bank Co. last year defaulted on a wealth management product. The bank said in December that it will negotiate possible repayment with investors who lost money in the incident, which involved structured deposits that a former employee is suspected of promoting without authorization.

The trial that also involves companies including Shenyin & Wanguo Securities Co., China Securities Co. and Industrial Securities Co., will at the same time bring China’s securities regulator into the market, thereby increasing investor protection, Liew said.