House of the year, Hong Kong: Guotai Junan

Asia Risk Awards 2019

Guotai Junan, the Hong Kong arm of the eponymous Chinese securities house, prides itself on an ability to deliver the sorts of tailored structured solutions others cannot.

“Here, equity is all about creativity,” says Eugene Yeung, an executive director, equity derivatives at Guotai Junan in Hong Kong. “We put together cross-border structures to make financing cheaper for clients and help them gain leverage, while at the same time satisfy risk management.”

In 2018, the securities house’s fixed-income and currency division ranked second in both the Bloomberg Asia Ex-Japan G3 currency high-yield league table in deals issued and total volume, and high-yield property issuance in total volume and deals. The firm has also been rapidly growing its equity derivatives and wealth management businesses. Over the past three years, income from financial products has seen a compounded annual growth rate of about 164%.

In equity derivatives, Guotai Junan International’s central philosophy is that structuring is not about making tweaks to payoffs, or introducing funky new underlyings – it is something more fundamental.  

“Some firms are more focused on the payoff; they are more focused on designing a product for end-investors to buy,” says Yeung. “But derivatives within our firm is more along the line of achieving specific financial objectives and saving cost. That’s real structuring, as opposed to the payoff engineering.”

One recent example of the firm’s creativity in designing equity derivatives solutions is a transaction that helped a client transition ownership of a Chinese medical company to a Cayman Island-domiciled offshore holding company, through a variable interest entity restructuring.

Variable interest entities are structures that give overseas investors de facto control over onshore Chinese companies in industries where foreign direct investment is restricted.

Guotai Junan International facilitated the restructuring by becoming a shareholder in the offshore holding company, and then passed the economic benefits and shareholders of the shares through a structured note issued to China’s Qualified Domestic Institutional Investor (QDII) scheme.

Some firms are more focused on the payoff; they are more focused on designing a product for end-investors to buy. But derivatives within our firm is more along the line of achieving specific financial objectives and saving cost

Eugene Yeung, Guotai Junan

The QDII repackaged the structured note into an onshore trust product, thereby channelling all the economics of the shares back to the onshore company.

The transaction is expected to last three to five years, with the client unwinding their shareholding of the holding company through Guotai Junan International in the secondary market at or before the maturity date of the structured note.

“This transaction involved a share swap between our client onshore and the holding company offshore, and they could not do that directly because of the currency controls,” says Yeung. “So they had to go through the QDII programme. They went through us, and we helped them divest at an agreed price.”

The manager of the trust product says Guotai Junan International demonstrated a high degree of competency in both the structuring of the deal and in the surrounding legal negotiations.

“I was very impressed by their ability to design structured products and to communicate with lawyers from Cayman, mainland China and Hong Kong,” the trust manager says.

Another area of growth for the equity derivatives department in 2018 has been the development and implementation of quantitative investment strategies and their formulation as rule-based indexes.

The number of professional investor clients on the firm’s books increased by 40% year-on-year and the actively managed index, the H Share Earning Growth Index, aims to leverage this trend, says Yeung.

“When those professional investors come in, the market sentiment changes a little bit,” he says. “People start to focus more on that fundamental stuff.”

The index focuses on earnings growth – a classic fundamental indicator. A monthly rebalancing is undertaken using Guotai Junan’s analyst forecasts for the next quarter, filtering thousands of Hong Kong stocks to find those with a solid market capitalisation, liquidity and positive earning adjustments.

The H Share Earning Growth Index has outperformed the Hang Seng China Enterprises Index by about 11.10% annually since inception, while volatility remained 9% below the volatility of HSCEI.

This type of quantamental strategy, incorporating both technical and fundamental indicators, is beginning to gain traction with the firm’s Chinese investors.

“Strategies like this will be a bigger part of our company going forward,” says Yeung. “We are seeing Chinese investors take more interest in QIS products.”