(Bloomberg) -- China is moving to curb “snowball” derivatives after brokers hiked returns to near-record levels to attract investors to the risky products following a stock-market selloff, according to people familiar with the matter.

Officials this week told some of the biggest brokerages to suspend any increase in their net exposure to over-the-counter derivatives involving domestic A shares, including snowball products which are based on options contracts, said the people. While the restrictions are temporary, the regulators didn’t indicate when they may be lifted or eased, the people said, asking not to be identified as the communications are private. 

The crackdown adds to a range of restrictions imposed on other derivatives businesses since late last year as Beijing pledged to stabilize its stock market amid an uncertain economic outlook and waning investor confidence. Bloomberg News reported on Monday that some brokerages were using coupon rates of more than 40% to attract investors back into the snowball market.

The move also comes as the ruling party’s disciplinary watchdog starts a new round of inspections at financial regulators and other state entities.

The China Securities Regulatory Commission didn’t immediately respond to a faxed request for comment. 

Snowballs are exotic options that pay bond-like coupons as long as the stock index they reference stays within a predetermined range. The longer the investors hold the product, the bigger the return — like a rolling snowball. Similar offerings cost Natixis SA almost $300 million in 2018.

An estimated 330 billion yuan ($46 billion) of snowballs were outstanding as of November, according to UBS Securities Co. 

Brokerages launched the price war to win back investors after the market rout earlier this year, when most snowballs fell through levels that threatened to wipe out coupons or even impose losses. The so-called “knock-ins” prompted brokerages to sharply increase purchases of stock-index futures and later sell them to limit risks. That exacerbated the stock-market slump by widening the discount with underlying indices and forcing quantitative hedge funds to unwind positions.

As the market stabilized gradually, two snowball products issued last month offered coupon rates of more than 40%, a level unseen since at least 2022, according to data compiled by Galaxy Technologies, which didn’t identify the issuers. The intensifying price competition is adding to pressures on profitability as securities firms seek to revive sales to help offset mounting hedging losses.

While regulators have already curbed some other derivatives businesses like the so-called Direct Market Access products favored by quant funds, they had until now refrained from imposing fresh restrictions on snowballs, the people said. In 2021, authorities asked brokerages to gauge risks tied to the products and ensure they are only sold to qualified investors, Bloomberg reported at the time. 

China’s OTC derivatives market has been a battleground that top brokerages from Citic Securities Co. to China International Capital Corp. “must fight for” in recent years, contributing stable profits, according to an Industrial Securities Co. report in January.

The options business, which includes products such as snowballs that are often tied to A-share indices, is a main pillar for the OTC market. Its outstanding value has surged more than 10 times since 2015 to 1.4 trillion yuan as of July 31.

--With assistance from Zheng Wu.

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