Morgan Stanley Returns to a Tough Trading Niche in Hong Kong

(Bloomberg) -- Morgan Stanley is wading back into a difficult niche of the Hong Kong stock market, betting it’s found a way to complement its business serving wealthy clients.

As protests roiled the city in recent months, the bank quietly began offering derivatives in Hong Kong known as callable bull or bear contracts, which track the performance of underlying assets without buying them directly. This week, the firm also began issuing warrants that can be traded at the Hong Kong Stock Exchange, helping fill a void left by European banks that have been pulling back from equities units with low returns.

Together the listed contracts amount to a $733 billion market in Hong Kong, but because of thin spreads banks have to amass market share to produce adequate profits. For New York-based Morgan Stanley, the new retail products may provide a way to neutralize risks in its growing private bank in Asia. Many wealthy clients want the firm to help them bet stock prices will remain relatively steady -- known as shorting volatility -- trades that typically involve selling derivatives. Now, essentially taking the other side, retail investors can buy Morgan Stanley’s new contracts to bet on price swings.

“We have returned to the HKSE warrant market with the technology and client focus necessary to establish a successful standalone business,” Craig Verdon, head of the institutional equity division for Asia said in a statement. “We anticipate synergies with our growing wealth-management business and our leading cash-trading client franchise.”

Citigroup, JPMorgan

European banks such as Barclays Plc, Standard Chartered Plc and Deutsche Bank AG have been paring Asia equities businesses including warrants trading as part of broad restructuring efforts, giving some rivals an opening.

Citigroup Inc. also aims to return to that business in Hong Kong after exiting it years ago, a person familiar with its planning said, asking not to be named discussing internal deliberations. A spokesman declined to comment. JPMorgan Chase & Co., a more established player in that part of the Hong Kong market, began expanding its business into Thailand last year.

Stock derivatives are popular in Asian markets, and investor demand for contracts to bet on equities in Hong Kong has remained robust despite the banks’ comings and goings. For small investors, warrants and other listed derivatives provide exposure to moves in an underlying stock or index for a fraction of the price of buying them directly. Trading in Hong Kong-listed structured products rose to a record $733 billion last year, a 38% increase from the start of the decade.

Asia’s stock derivatives have proven tricky at times for overseas banks. France’s Natixis SA was left reeling last December after trades linked to volatile Korean financial products known as autocallables went awry, triggering losses and provisions of 259 million euros ($286 million).

Technology Focus

Morgan Stanley was among banks that quit the listed-warrants business in Hong Kong years ago, getting out just before the global credit crisis because of too little volume at the time. The lean spreads can make profits difficult, despite the risks.

“Scale is incredibly important in this business, given the volatility of the market and the ongoing investments required to lead the market in serving clients,” Yowjie Chien, JPMorgan’s Hong Kong-based global head of warrants & options electronic client solutions, said in an interview. “We’ve grown significantly in terms of market share over the last nine years.”

Morgan Stanley is hoping cutting-edge technology can help it with that challenge and allow it to operate a high-speed platform. The bank has assembled more than a dozen people dedicated to its new warrants unit, according to a person with knowledge of its business. Roughly two-thirds of that group will focus on the underlying tech, with the remainder working in quant strategy, trading and sales, the person said.

Listed structured products amounted to more than 20% of trading volume at the Hong Kong stock exchange last year. Bull or bear contracts allow retail buyers to make leveraged bets. To limit their losses, the products are canceled if underlying stocks exceed predetermined amounts.

Morgan Stanley does little retail business in the region. It offers wealth management to retail investors in Australia and provides some products to third-party private banks that incorporate them into their own retail offerings. While the new warrants are a retail product, Morgan Stanley will issue them on the exchange and won’t interact directly with buyers.

The bank is returning to the market as regulators, hoping to cultivate a wider range of warrants and derivatives contracts, adjust rules to speed up product approvals. Executives declined to say how much they hope to earn by offering the contracts.

To contact the reporter on this story: Cathy Chan in Hong Kong at kchan14@bloomberg.net

To contact the editors responsible for this story: Candice Zachariahs at czachariahs2@bloomberg.net, David Scheer, Jonas Bergman

©2019 Bloomberg L.P.