Unlock the Editor’s Digest for freeRoula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.Chinese retail investors who invested heavily in derivatives that depend on stable market conditions have suffered substantial losses, further damaging confidence in the struggling equity market in the country. These so-called snowballs, which guarantee a continuous stream of substantial interest payments as long as stock indices stay within a specific range, have expanded to an estimated Rmb320bn ($45bn) market in China. Brokerages and private wealth managers promoted the sale of these derivatives in 2021, emphasizing the higher returns available during a relatively calm period in the equity markets. However, a prolonged stock market decline since late 2023 has caused the indices to breach the lower limit embedded in the contracts, resulting in knock-ins. As a result, many holders are now facing significant losses on their original investment unless stocks rebound. Most of the estimated Rmb327.5bn of outstanding snowballs are tied to the CSI 500 index of Shanghai- and Shenzhen-listed stocks and its small-cap counterpart the CSI 1000, according to Zhao Wei, an analyst at Sinolink Securities. Zhao stated that a “wave” of snowballs were “knocked in” when some Chinese stocks hit a five-year low. Markets have since stabilized following Chinese Premier Li Qiang’s pledge of “forceful” state support to halt the sell-off. Retail investors are now dealing with substantial losses on investments that were marketed as relatively safe alternatives to bank deposits. According to the head of a medium-sized Chinese brokerage that sells snowballs, the sales team initially marketed the products by asking clients if they believed the CSI 500 could fall by more than 20% and if not, they should buy a snowball as a secure bet. Stephanie Liu, a 34-year-old clerk in Shanghai, joined forces with friends to purchase Rmb1mn worth of snowballs in June 2022. The contracts offered a 15% yield over two years as long as the CSI 500 did not fall more than 20% or rise more than 3%. Now, her contract is on the verge of a “knock-in” threshold that would trigger a 20% loss on her original capital unless there is a significant market rebound by June. She expressed feeling helpless and guilty, stating, “It is a situation that has no solution. It’s not the right question to ask why we bought snowballs, but why the index is performing like this.” Despite their small size relative to the Chinese equity market as a whole, analysts said the wipeout for some snowball holders could exacerbate the country’s stock rout. Brokerages that sell the contracts typically buy stock futures to hedge their position. When knock-ins are triggered, they have to sell those hedges. In a downturn market, futures trading in link with snowball positions could intensify the selling pressure on Chinese stocks, according to Yu Mingming, an analyst at brokerage Cinda Securities. The China Securities Regulatory Commission urged brokers in 2021 to strengthen their risk controls on snowballs and refrain from marketing them as fixed-income products. However, the sector remains relatively loosely regulated. The CSRC did not immediately reply to a request for comment. Complex derivatives in products such as snowballs have backfired for Asian investors before. In 2009, several major banks incurred heavy losses after South Korean courts released hundreds of companies from contracts that could prove ruinous if the won moved outside set ranges. South Korean retail investors’ interest in so-called autocallables has also been blamed for negatively affecting European stocks and reducing US stock volatility. Additional reporting by Jennifer Hughes in New York
