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Chinese retail investors hit by big losses in ‘snowball’ derivatives

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Chinese retail investors who loaded up on derivatives that rely on calm market conditions have been hit with heavy losses, further undermining confidence in the country’s sputtering equity market.

So-called snowballs, which promise a stream of sizeable interest payments as long as stock indices trade within a certain range, have grown to an estimated Rmb320bn ($45bn) market in China.

Brokerages and private wealth managers increased sales of such derivatives — named because of the steady returns they can accumulate for holders — in 2021, touting the higher yields on offer at a time when equity markets were relatively placid.

But a protracted stock rout since late 2023 has led to indices breaching a lower limit embedded in the contracts, triggering so-called knock-ins that leave many holders facing substantial 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 Sinolink Securities.

Zhao said there had been a “wave” of snowballs “knocked in” when some Chinese stocks sank to a five-year low this week. Markets have since been steadied by Chinese Premier Li Qiang’s promise of “forceful” state support to halt the sell-off.

Retail investors are now left nursing big losses on investments they say were marketed as relatively safe alternatives to bank deposits.

“The sales team will start the marketing by asking this to their clients: do you believe the CSI 500 could fall by more than 20 per cent? If not, you should buy a snowball as a safe bet,” said the head of a medium-sized Chinese brokerage that sells snowballs.

Stephanie Liu, a 34-year-old clerk working in Shanghai, clubbed together with friends to buy Rmb1mn worth of snowballs in June 2022. The contracts offered a 15 per cent yield over two years as long as the CSI 500 did not fall more than 20 per cent or rise more than 3 per cent.

Now her contract is on the verge of a “knock-in” threshold that would trigger a 20 per cent loss on her original capital unless there is a significant market rebound by June.

“I feel helpless and guilty [because of] my friends,” she said. “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,” said 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. Still, 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 lost heavily after South Korean courts extricated hundreds of companies from contracts that could prove ruinous if the won moved outside set ranges.

South Korean retail investors’ appetite for so-called autocallables has also been blamed for hurting European stocks and depressing US stock volatility.

Additional reporting by Jennifer Hughes in New York

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