Sharp falls in an important index of Chinese companies have raised fears that the need to hedge billions in linked derivatives will add to volatility in the region — potentially depressing markets even further.

Dealers have been watching the Hang Seng China Enterprises index — consisting of the Hong Kong-listed shares of large Chinese groups — because of its heavy use in structured retail products, particularly in South Korea.

Almost $40bn of so-called “autocallables” linked to the HSCEI were outstanding at the end of last year, according to the Korea Securities Depository. The products are designed to pay investors capital plus interest if agreed securities stay within specified bands, but the holder faces capital losses if a reference security falls below that level.

On Wednesday the HSCEI closed at 8,015.44, down 4.3 per cent — by far the worst hit of Asia’s main indices. It had dipped to 7,915.17 — its lowest level since March 2009.

So far this year it has dropped 17 per cent, compared with 15.9 per cent for the Shanghai Composite, with which it shares many blue-chip names.

Strategists said most strikes — the level at which investors stand to lose heavily — were below 8,000, with a particular concentration around 7,800.

“Until we get down to that level and clear out the strikes, bounces in the market are likely to continue to be sold,” said Mohammed Apabhai, head of Asian trading at Citigroup.

As the levels neared, banks that sold the products had to sell more futures contracts to hedge their exposure — which was likely to increase the pressure on the HSCEI.

“Hedging needs are only one part of the futures market,” said William Chan, head of Asia-Pacific equity derivatives research at Bank of America Merrill Lynch. “But hedging for these products at these levels will accelerate selling in downward days — they’re not supportive at all.”

Dealers fear that further falls in the index could force institutional investors to sell some of their holdings — exacerbating the downward trend.

HSCEI-related products make up 60 per cent of the autocallables market in Korea, which recorded record sales last year.

Sales were heavily concentrated in the first half, when the index reached 14,801, aided by China’s massive market rally.

Autocallables, which usually carry a maturity of two or three years, typically feature a “worst of” basket, with so-called “knock-in, knock-out” triggers based on the best or worst performer of two or three reference securities such as the HSCEI or Korea’s benchmark Kospi index.

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