Increasing volumes in HKEX’s MSCI China A 50 Connect (USD) Index Futures point to growing appetite for A-share hedging tools that can offer a sector-balanced China exposure.

Launched in October 2021, the new contract now accounts for about 25% of the offshore China A-share futures market in the day trading session.¹ Average daily turnover for March reached a record high of 24,807 contracts, equivalent to a notional amount of US$1.5 billion, while open interest ended the month at 24,504 contracts (notional value: US$1.5 billion). 

Fig. 1) Trading volumes have been growing steadily since the launch

Source: HKEX, data as of 29 April 2022

Effective hedge

A key driver of this growth is the index’s balanced approach to its sector allocation, which aims to offer broad diversification. Financials and industrials are the two biggest sectors in the MSCI China A 50 Connect index, representing about 35% of index weight, same as the broad-based MSCI China A Index’s top two sector weightings.² In comparison, the underlying index of an alternative offshore A-share contract – the FTSE China A50 Index – has a combined weight of 57% in its top two sectors, financials and consumer staples.³

Fig. 2) Sector weight comparison

Source: MSCI factsheet, Bloomberg, data as of 31 March 2022

The sector-neutral approach of the MSCI China A 50 Connect Index means that it can be used to address the risk management needs of balanced China portfolios, better reflecting the Chinese economy. It also leads to higher correlations with broad-market A-share benchmarks when compares with the underlying index of the other offshore China A-share index futures, providing investors with an additional hedging tool for broad-based China portfolios.

Table. 1) Correlation with broad-based indexes

Source: Bloomberg, MSCI, data for the 12 months ending April 2022

Volatility-tested

The overall market quality of the MSCI China A 50 Connect (USD) Index Futures remained intact despite high market volatility. During the recent stock market fluctuation in mid-March, which coincided with the expiry week, the contract’s average spread remained stable at 1.3 bps⁴ in the calendar spread book. Meanwhile, its average best-bid-offer (BBO) size reached over US$3.6 million. Supported by strong liquidity, the roll went smoothly with more than US$13.8 billion notional value traded in the roll week.

Furthermore, the underlying index exhibited consistently lower tracking error to the broad A-share market compared with index constructed by simply selecting the 50 largest A-shares. The difference in tracking performance was especially stark amid volatility spikes, at times when protection is most needed.

An expanding product ecosystem

Given the growing demand for the MSCI China A 50 Connect Index, various market players have launched related products in Hong Kong and beyond to seize this opportunity. By the end of March 2022, there were nine ETFs tracking the index with a combined AUM of US$5.4 billion (US$4.5 billion in four onshore ETFs and US$0.9 billion in five offshore ETFs).

Stock Connect – the China A-share direct access channel in Hong Kong – is well positioned to support the expansion of products related to the MSCI China A 50 Connect Index. In March 2022, the average daily turnover of the top 10 index constituents traded through Northbound Stock Connect reached US$6.5 billion. All constituents of the MSCI China A 50 Connect Index are Stock Connect-eligible, which means that product issuers can create and manage index-related products conveniently through a single A-share trading channel. 

Holiday trading

Hong Kong’s enhancing market structure plays another key role in supporting offshore product development. The launch of HKEX’s Derivatives Holiday Trading service on 9 May 2022 further supports the growth of MSCI China A 50 Connect (USD) Index Futures. All MSCI futures and options are included as the first batch of holiday trading products, helping investors manage their portfolio risks more effectively and potentially driving increased participation in Hong Kong’s derivatives market.

Holiday trading could also support the growth of the new MSCI China A 50 Connect (USD) Index Futures by allowing investors to trade the contract and perform risk management on their A-share exposure during Hong Kong holidays.

The unique features of the new contract, coupled with Hong Kong’s deep liquidity and broad investor base, are set to make the futures an essential part of China portfolios held offshore.

1 In terms of the notional value of average daily turnover in March 2022

2 Source: MSCI factsheet, data as of 31 March 2022

3 Source: Bloomberg, data as of 31 March 2022

4 During the T sessions of 14-17 March