A lack of hedging options to smooth volatility for investors buying mainland shares is holding back institutional money managers from fully exploiting the Shanghai-Hong Kong Stock Connect trading scheme, industry insiders say. The need will become even more pressing with the extension of cross-border stock trading to Shenzhen, expected this year, especially if it eventually includes Shenzhen's tech-heavy, Nasdaq-style ChiNext board, which is even more volatile than the city's main board. Market participants are keen to have an overseas stock-index futures market that provides ample trading liquidity and covers small-cap stocks, as they worry that domestic retail investors might flood out of the mainland stock markets in the event of a sharp downturn. The launch of stock-index derivatives or other means to hedge against downside risk is the next step in encouraging investment through the stock connect scheme, after the Hong Kong stock exchange moved last month to ease concerns over a pre-trade checking requirement that could have exposed sell orders. Hong Kong Exchanges and Clearing chief executive Charles Li Xiaojia said in February that he hoped to see the licensing of futures for northbound investors this year. Yin Zhong-li, a researcher at the Chinese Academy of Social Sciences, said adding Shenzhen-traded technology and small-cap companies to the extension of the stock connect scheme would be another major achievement in Beijing's efforts to reform the mainland's capital markets. He said the stock connect scheme could help contain the bubble in Shenzhen's ChiNext market, which is trading at valuations five times higher than Hong Kong small-caps. Patrick Wong, head of China sales and business development at HSBC Securities, said the FTSE China A50 futures provided overseas investors with only a limited means of hedging since the contracts, traded in Singapore, covered only large-cap stocks. They are the only mainland A-share index futures tradable outside the mainland. Daily turnover of the large-cap CSI 300 Index futures has reached US$246 billion since April 10, compared with US$2.5 billion for FTSE China A50 futures, according to BNP Paribas. Wong said the possibility of short-selling exchange-traded funds listed in Hong Kong that traded in mainland small-cap indices could be an alternative way to hedge in future. Under the stock connect scheme, short-selling of certain Shanghai-traded A shares has been allowed since March 2, but a low inventory of mainland stocks prohibits investors from benefiting from a fall in share prices. Northbound investment through the stock connect scheme is limited to the constituents of the SSE 180 benchmark index and the SSE 380 index of newer, mid-cap blue chips. Keith Pogson, senior partner at accounting firm EY, said the stock-index futures should work best for investors seeking liquidity and a range of product offerings. "The short market is still new, inconsistent as to liquidity and often expensive," he said. Alexandre Godingen, from Fidessa, a provider of trading technology for financial markets, said increased regulation, capital requirements and higher operational costs were among the reasons few hedging products were offered by brokerage firms. Two new stock index futures have given mainland investors tools to take bearish views on the A-share market since the middle of last month. Futures on the small-cap CSI 500 index and the SSE 50 index of the largest companies listed in Shanghai started trading on April 16, offering investors new channels to bet on a major correction in the red-hot stock markets. Citi says it expects the expansion on the stock connect scheme to Shenzhen could happen soon, with the infrastructure and operational preparations complete. "It takes time for the stock connect programme to expand the investment scope," said Cindy Chen, Hong Kong country head of securities services at Citi. She said one of the major differences between the stock connect scheme and the two quota systems - the qualified foreign institutional investor scheme and the renminbi qualified foreign institutional investor scheme - was that investors under the quota systems could buy a variety of products, including mainland initial public offerings, mainland funds, interbank bonds and derivatives for hedging. "Equity derivatives are one of the natural types of instruments, offering investors the necessary protections when investing in the China market," Chen said.