Investment banks and stock brokers are expected to issue more derivative instruments such as warrant and callable bull/bear contacts (CBBCs) with underlying assets related to those shares included in the list of Shanghai-Hong Kong Stock Connect (SH-HK Stock Connect), Societe Generale (SG) Securities (Hong Kong) said.

According to two brokers, Credit Lyonnais Securities Asia and CITIC Securities, mainland investors tend to favor red chips and mainland State-owned enterprises (SOEs) and large-cap stocks with global business footprints. Also in favor are those mainland private sector companies and casino operator stocks.

Hong Kong-listed shares which enjoy a valuation premium over their counterparts in the Shanghai stock market are likely to attract mainland investors' interests as they can generate short time profits through arbitrage - buying in the undervalued Shanghai A-share market and selling in the overvalued Hong Kong market.

According to SG data, capital flow into those CBBCs in the third quarter reached HK$364 million ($46.9 million), up 12.1 times from the second quarter; while investment in "H-share discount stocks" CBBCs also increased to HK$54 million in the same period.

"With the imminent launch of the Stock Connect, more capital will flow into Hong Kong's equity market, making the market more volatile. (For that reason,) warrant and CBBCs investors should be more vigilant in managing their investment risks," SG Securities (Hong Kong) Head of listed Products Sales Keith Chan said.

"Whether investment banks will issue more warrant and CBBCs related to Stock Connect beneficiary shares depends on how liquid they are because it is essential for issuers to hedge their investment positions through purchasing or selling the stocks easily in the market," Chan continued.

"Warrant and CBBC derivative product issuers, based on the latest market trend, will issue warrant and CBBCs at strike prices near to the share market price. Therefore, I predict the issuance of warrants and CBBCs will be maintained at a relatively high level, "SG Securities (Hong Kong) vice-president Horace Chow added.

Looking forward to the fourth quarter market performance, SG Securities (Hong Kong) predicted trading in warrants will account for about 13 percent of the Hong Kong stock market's total turnover; while that for CBBC will account for up to 9 percent.

The investment bank said that total warrant turnover rose 63 percent to HK$626 billion, accounting for 13.9 percent of the total market turnover in the second quarter; while CBBC transactions surged 39 percent to HK$338 billion, or 7.53 percent of the total market turnover in the same period.

oswald@chinadailyhk.com

(HK Edition 10/14/2014 page9)