Mainland China stock suspensions have traders guessing on derivatives

The suspension of hundreds of mainland stocks during a market plunge that began last month could lead to disputes between banks and their clients over the valuation of billions of dollars of equity derivatives.

Banks dealing in derivatives are concerned that valuation terms covering market disruptions in other Asian markets, such as trading halts when stocks move up or down by the exchange’s daily range limits, might not apply to the wave of stock suspensions on the mainland.

As mainland stocks tumbled by 30 per cent in less than a month, around 1,500 listed companies, more than half the market, suspended their own stocks in a bid to sit out the rout.

“It’s not yet clear if the existing disruption event language for other Asian jurisdictions can be applied to China or how the existing disruption definitions for limit-up, limit-down would apply to suspended stocks,” said Keith Noyes, Asia-Pacific regional director at the International Swaps and Derivatives Association (ISDA), which represents the world’s largest derivatives dealers.

Noyes and an in-house lawyer at a major Asian dealer said banks were reviewing the issue.

“There could be wrangling over issues such as whether the Shanghai Composite Index closing price, which would generally be the easiest to use to value contracts, is a good price or a disrupted price, given that so many stocks are now suspended,” Noyes said.

Dealers have written at least US$150 billion of outstanding over-the-counter equity derivatives on mainland-listed shares, according to estimates by Shanghai-based investment consultancy Z-Ben Advisors.