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When your stock market is bleeding and your currency is under pressure, you don’t exactly want domestic money fleeing for greener pastures. China International Capital Corp, one of the country’s most prominent state-owned brokerages, has stopped clients from adding new positions in cross-border total return swaps, effectively slamming a door on one of the more popular routes for moving capital offshore.
At least three other major state-owned brokerages followed suit with similar restrictions. The timing is not subtle: the CSI 300 Index had just slid to its lowest level since early 2019, and regulators were clearly in no mood to watch billions more flow out of the country through derivative instruments.
What are total return swaps and why do they matter here
Think of a total return swap as a financial workaround. Instead of directly buying shares listed on, say, the Nasdaq, a Chinese investor enters a contract with a brokerage. The brokerage takes the actual position in the foreign asset and passes along the returns (or losses) to the client. In English: you get exposure to overseas stocks without technically sending money abroad.
As of late November 2023, the total cross-border OTC derivatives book at Chinese brokerages, which includes TRS products, stood at 825.4 billion yuan. That’s roughly $114.7 billion worth of positions.
CICC is one of only ten Chinese brokerages licensed to offer TRS services, which gives it an outsized role in this corner of the market. When a firm of that stature pulls the plug on new positions, it sends a signal that reverberates well beyond its own client base.
Beijing’s broader crackdown on capital flight
The restrictions didn’t come out of thin air. Regulatory guidance issued in late 2023 had already targeted leveraged derivatives trading, laying the groundwork for the more explicit bans that arrived in early February 2024.
Cross-border TRS products had become a pressure valve, allowing sophisticated investors to effectively move capital offshore in derivative form, bypassing the cumbersome Qualified Domestic Institutional Investor (QDII) quota system. The restrictions align with a broader strategy by the securities regulator to stabilize financial markets and curb what officials have described as abnormal market fluctuations.
By restricting new positions rather than unwinding existing ones, regulators struck a balance. Current holders can maintain their exposure, but the pipeline of fresh capital flowing into foreign assets through this channel is effectively frozen.
What this means for investors
For domestic Chinese investors, the immediate consequence is a narrower menu of options for gaining offshore exposure. Some may turn to the QDII system, which allocates limited quotas for overseas investment. Others may look toward Hong Kong-listed stocks through the Stock Connect programs as a partial substitute.
Disclosure: This article was edited by Editorial Team. For more information on how we create and review content, see our Editorial Policy.
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