ON Monday Nov 23, SGX launches five new regional and single-country futures contracts based on Net Total Return and Price Return Indices calculated by FTSE Russell.

 

The two Price Return Indices are the SGX FTSE Emerging Market Index and SGX FTSE China 50 Index, with both Indices related through their significant exposure to China.

 

China stocks make up 48 per cent of the SGX FTSE Emerging Market Index, with non-China Asian stocks contributing another 30 per cent to the Index weight. The SGX FTSE China 50 Index comprises China stocks listed in Hong Kong, which includes H-shares, Red Chips and P Chips, including big tech brands such as Meituan Dianping, Tencent Holdings, Alibaba Group Holding and Xiaomi Corp.

 

With the region' s biggest economy the common attribute, the daily price moves of the two indices have seen 95 per cent correlation over the past five years. However, the two indices provide very different thematic perspectives applicable to investing in China.

 

To some investors, the US$14 trillion economy represents the flagship economy of the global emerging markets, while other investors may see the China market from the perspective of the prominent tech companies listed in Hong Kong.

 

Recent market swings have shown just how different these two dynamics can be, resulting in significant dispersion among the China-focused indices. Amid the broader market volatility earlier in the year, from Feb 3 to April 3, the FTSE China 50 Index saw only one-third the percentage declines of the FTSE Emerging Market Index. Then from April 3 through to Sept 29, the FTSE Emerging Market Index posted three times the percentage gains of the FTSE China 50 Index.

 

The two futures contracts based on the FTSE Emerging Market Index and FTSE China 50 Index will maintain initial margins of US$3,300 and US$2,310 respectively.

 

The corresponding notional values of the two new contracts are US$56,000 and US$52,000 based on Friday Index levels.

 

While the long-term correlation of the two Indices will potentially qualify spread traders of the two new futures contracts for margin offsets of up to 75 per cent, margin offsets will logically extend to existing futures contracts. For instance, spread trading the futures contracts based on the FTSE China 50 Index and FTSE China A50 Index will qualify for up to 63 per cent margin offset, based on the current margining schedule.

 

With the combined market value of China incorporated stocks more than tripling over the past 10 years, it is a given that China-related derivatives should not just grow, but also provide the most relevant thematic means for investors to participate in these markets.

MAYBANK Kim Eng (MKE) has initiated coverage on Singapore Exchange (SGX) with a " buy" rating, and a target price of S$10.77, in a research note dated Monday.

 

" SGX has evolved from a cash-equities exchange to a pan-Asian, multi-asset platform offering derivatives, fixed income and alternative products," Thilan Wickramasinghe, head of research at MKE wrote. " This positions it to benefit from multiple structural trends that are driving demand for risk-management products" .

 

He noted that SGX has built deep liquidity pools and sizeable market share in key risk management derivative products, which gives it a competitive advantage over regional exchanges

 

The brokerage said SGX' s non-cash equities businesses contributed 62 per cent of revenues in FY2020 from just 38 per cent in FY2012. It estimates the revenue share to rise to 74 per cent by FY2023, underpinned by higher volumes in SGX' s product suite of index, foreign exchange and commodity derivatives.

 

MKE expects risk management-driven derivative volume to continue to rise, driven by factors such as rising market volatility and stricter regulations. These factors can allow for complementary positioning of SGX' s product offerings, it said.

 

MKE also said that SGX has built a comprehensive product suite that provides investors with opportunities to manage risks as the operating environment in Asian markets evolve.

 

It added that a critical success factor SGX has built up is to support deep liquidity in its key product offerings. " We believe that once a strong level of liquidity is created within a trading venue, it is harder for a rival to come in and take away market share - even if the pricing is competitive," MKE said.

 

On the other hand, the brokerage noted that SGX' s cash equities business is " ex-growth" , with delistings outpacing initial public offerings by 40 per cent since FY2012.

 

Over the last 10 years, SGX cash-equities revenue have contracted at a 1 per cent compound annual growth rate, MKE said. While FY2020 delivered higher revenue from a Covid-19 trading boost, it believes it to likely be an exception rather than the rule.

 

The brokerage expects segment contributions to continue to contract going forward, primarily due to limited hinterlands available to SGX to keep cash equity momentum supported, and limited sectors offering attractive listing valuations.

 

Still, the segment could continue to provide a key support for dividend visibility going forward, MKE said, as the segment offers strong operating leverage.

 

The brokerage estimates that revenue generated above a market average daily value (ADV) of S$580 million will flow directly to earnings before interest, taxes, depreciation and amortisation. It noted that the ADV for SGX has been twice the S$580 million level for the past five years.

 

" We believe this segment - while seeing low growth - should continue to be a key support for dividend visibility going forward."

 

MKE also said that SGX has room to add more growth through acquisitions. It noted that SGX' s debt-to-equity ratio, at 24 per cent, is lower compared to an average ratio of 67.5 per cent among peers.

 

" In a scenario where SGX gears up to peer average levels, we estimate the group should have an incremental S$539 million available for acquisitions and investments," MKE said.

 

The S$10.77 price target for SGX is based on a blended target price methodology, combining multi-stage discounted cash flow, and a peer basket price-to-earnings ratio driven methodology.