Hong Kong is a relatively vanilla market in global terms, and is very accessible. Dominated by offshore traders, it mainly operates bilaterally, although tri-party agents are often used to manage collateral. 

Collateral demands do not differ from other international markets. The main demand for borrowing securities comes from the increasing number of hedge funds via prime brokers in the financial centre and there are plenty of asset managers with sizeable assets under management to lend. Perhaps boosted by recent interest in Chinese volatility, Hong Kong is now the third largest securities borrowing and lending (SBL) market in the world, behind the US and Germany, according to Markit data. 

The one quirk that makes operating in the market unusual is the regulatory practice regarding stamp duty. SBL transactions are exempt from stamp duty, but the contracts need to be registered within 30 days of trading. 

While it is not particularly cumbersome or time consuming to register the contract, participants need to be familiar with the rules, according to Ariel Winiger, head of securities finance, Asia Pacific at Societe Generale. “Lenders need to be careful about automatic buying rules, when you can’t satisfy your sale, you get bought in automatically,” he adds. 

The cost to borrow is relatively volatile. In 2012, average cost to borrow rose well above 200bps before gradually coming down, only to shoot back up again in early 2015. The recent volatility in Asian markets means this trend is likely to continue. 

“One of the drivers of high SBL fees are ETFs, explains Winiger. “For example, right now the interest in China-related ETFs is at a very high level as it allows participation on the downside of the Chinese market. Therefore there’s not very much availability at all and fees are correspondingly high.” 

“There hasn’t been a huge amount of innovation in the market of late, except of course the rise of ETFs in the last few years and Shanghai-Hong Kong Stock Connect programme, there’s definitely a lot of activity in that space.” 

In May 2012 the Hong Kong Stock Exchange (HKEx) tightened the rules that regulate the short selling of designated securities. It tripled the market capitalisation for eligible stocks to HK$3bn ($385m) and increased turnover velocity from 40% to 50%.

“Regulators in Hong Kong have always had quite a stable approach, says Winiger. “They have clear rules about how the stock lending market and short selling work. The regulators have been very consistent and kept the environment very steady, which is comforting to market participants.” 

Synthetics 

When financing Hong Kong securities, almost all equities incur a 10bps stamp duty on the sale or purchase, which significantly reduces cost efficiency. 

Since many synthetics require two trades, the cost of stamp duty is incurred twice – for this reason the market prefers to finance through stock lending and repo. However, the same rules do not apply to ETFs which can be bought and sold freely without being impacted by stamp duty. 

Be that as it may, the increasing number of Hong Kong-domiciled hedge funds and the trend for more to register as UCITS funds, which can only short sell using synthetic financing methods, is providing a boost to the market. 

Repo 

Most of the repo traded in Hong Kong is in CNY and USD. There is also some in EUR. The HKD repo market is relatively limited in size and depth. This is in part because the bond market is fungible, meaning that traders can net long and short positions, so there is no need to cover short positions, and in part because Hong Kong banks are well funded with no shortage of liquidity. 

Repo desks in Hong Kong use their London entity as a principal to trade as most Hong Kong entities don’t have a credit rating, according to Davin Cheung, Clearstream’s regional manager for North Asia, global securities financing. 

Equity financing trades tend to go through tri-party for funding purposes. This involves using an agent to take care of collateral issues such as allocations, custody, substitution and margining. “However there are also a lot of trades done bilaterally especially for specials where the underlying bonds or equities are borrowed for short selling purposes using repo trading structures,” says Cheung. 

In 2012, the Hong Kong Monetary Authority (HKMA) launched a repo financing programme in an attempt to develop the market further between Hong Kong’s clearing system members at the Central Moneymarkets Unit (CMU) and international banks. 

“JPMorgan, Euroclear and Clearstream each set up a platform to facilitate repo financing transactions between members of CMU and international financial institutions, but I think very little volume has been traded through this avenue up to this point,” says Ed Donald, global head of repo at Standard Chartered. 

Another more recent initiative of the HKMA was to designate seven banks as primary liquid providers (PLPs) for CNH in 2014. “Repo is one of the products offered by primary liquid providers. The idea is to improve Hong Kong’s standing as the world’s leading centre for CNH trading,” adds Donald. 

With its close links to both China and the international market, the future for Hong Kong securities finance looks bright.