Lack of quants dims chance of structured product boom in China

Quants in high demand as banks explore new products, and local rules call for onshore specialists

China's-quants-are-in-short-supply
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China’s mass wealth management market could be hugely lucrative, and steps by regulators to liberalise onshore markets create new opportunities for foreign firms to expand their range of structured products. But efforts to grow the business are now hitting what has become a familiar problem in Asia: a shortage of quantitative specialists able to risk-manage such offerings.

Jacob Wai, a consultant who has worked with a number of banks in China, is one subscriber to that view.

“The quant pool in China is not that big and it’s not growing. Of course, this is going to cause problems,” says Wai, the Hong Kong head of data and analytics for financial services at Capgemini.

The demand for quants in China is broadly driven by two recent trends. One is a move by banks into new types of structured products and the other is a rising need for local, rather than offshore, quants.

“Banks are trying to do things in China that they weren’t before and that’s why there is a premium on quant talent,” Wai says. “In the past, the primary structured products assets in China were equities but now we’re seeing a renewed focus in the credit and fixed income asset classes, and that is where quants and asset modelling are really important.”

China’s regulatory environment has turned increasingly favourable for structured investments in recent years. First, in 2018 the country’s regulators started cracking down on wealth management products based on off-balance sheet lending. The clampdown dovetailed with rapid expansion in the Chinese market for structured products – alternative offerings where customer money is invested in risk assets but with a guarantee wrapper to provide some protection for investors.  

Then, China’s market for structured deposits – yet another rival wealth management product – took a knock after the banking and insurance watchdog told the country’s banks in mid-2020 to make deep cuts to their balance sheet exposure to structured deposits.

This was followed by new legislation in November last year that removed restrictions on the borrowing of securities in the onshore market by foreign firms. And since the start of November this year, qualified foreign investors have been allowed to trade onshore commodity futures, commodity options and stock index options.

Dealers say these last two liberalisation measures – part of an overhaul of the country’s Qualified Foreign Investor scheme – open up new vistas for trading strategies and structured products.

Lastly, a new wealth management scheme linking Hong Kong and China’s Guangdong province, which started operating in October, provides another avenue for foreign firms to offer structured products in China. For now, among the banks given approval to use the scheme, only three are non-Asian: Citi, HSBC and Standard Chartered.

Boots on the ground

While the new opportunities are rich, tapping into them comes with quirks specific to China.

For one, using the newly available onshore derivatives to design structured products for mainland clients means trading them onshore as it is not possible to do so outside the country. The hedging of such products then needs to take place in mainland China too, requiring local quants.

The head of quant research for Asia at one European investment bank says it is more efficient “when a quant sits next to traders in order to offer new structured business ideas”, referring to ways of hedging the products.

Secondly, quants have a role in the engineering of structured products.

One senior quant at a global bank with a large onshore presence in China uses structures called accumulators as an example. Investors in an accumulator purchase an underlying security at a predetermined strike price. Another feature of accumulators is that they usually terminate early if the stock price goes above a certain threshold known as ‘the barrier’.

“You need local quant talent to determine what the strike price is and where the barrier should sit,” the quant says.

Working out those levels calls for specialist modelling skills and knowledge of the local market, and the latter is much easier to gain and maintain for quants based in China rather than offshore.

The quant adds that products such as accumulators should be backtested and constantly readjusted according to market needs, which is a much simpler task if quants and traders sit next to each other.

Certain information, such as client data and market risk limits, cannot typically be shared, so you won’t be able to have a global quant in China face security clients onshore
Senior quant at a US bank

A new data law in China is yet another reason why quants often have to be based locally.

“There are two different types of modelling quants in China – those working for the global business and those working for the local securities house – and there tends to be a wall between the two,” says a senior quant at a US bank.

“The role of the local quant team is to support the local trading desk on local names for local clients. Certain information, such as client data and market risk limits, cannot typically be shared, so you won’t be able to have a global quant in China face security clients onshore.”

From this perspective, global banks keen to capture a greater share of China’s structured product flows start off on an unequal footing. JP Morgan and UBS have sizeable onshore quant teams that they can tap into. In contrast, others, including Goldman Sachs and Morgan Stanley, have smaller teams, although Risk.net understands that both banks are looking to hire more local quants.

Neither Goldman nor Morgan Stanley would comment on their quant staffing plans in China. But beefing up headcount on the ground makes sense for both of them, given their recent expansion in the country.

Earlier this year, Goldman and state-owned Industrial and Commercial Bank of China announced a new joint wealth management venture, while Morgan Stanley decided to increase its share in its onshore securities entity, Morgan Stanley Securities (China). Once the equity transfer from the minority shareholder, Huaxin Securities, is completed, Morgan Stanley will own 90% of the entity.

Skill gaps

However, hiring more China-based quants won’t be easy.

“It is hard to find an onshore quant who can speak both English and Chinese and fit into an international banking culture,” says Monica Song, Shanghai-based managing director for financial services at Hudson, a recruitment agency.

“International banks are stricter when it comes to risk control,” she explains.

Chinese quants often cut their teeth in local firms, which does not necessarily equip them with the skills and experience that global banks need.  

“The large Chinese banks have traditionally used quants for regulatory reporting rather than risk modelling, and that requires a very different skill set,” says Capgemini’s Wai.

“While a standard quant model looks at things like future cashflow and tries to work out the theoretical price of the underlying assets, many Chinese banks typically start with an end-number and work backwards to find a model that fits,” he adds, highlighting the distinct application of quant techniques at local banks, where they are used mainly for regulatory compliance.

Global banks hungry for local quants may have seen a chink of light in the steady return of such specialists from the US in recent years, as US immigration laws have been tightened. But many of those who have come back have set up their own funds. Others have been snapped up by large state-owned Chinese banks as they expand their overseas footprint and work to bring their business more in line with global standards.

It seems that for now, foreign banks in China are stuck with their own version of Covid-era labour shortages.

Editing by Olesya Dmitracova

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