Less regulated funds, meanwhile, have been buying more complex, higher-value equity swap products which are often very profitable for the bank that typically finances the trade.
An equity swap involves counterparties agreeing to exchange two future cashflows, known as "legs" - one leg might be pegged to a market interest rate, for example, and the other tied to a stock or index performance.
"We have all types of clients trading synthetics, including long-only institutional funds," said Sebastien Mailleux, head of forward trading, Asia, at BNP Paribas Securities in Hong Kong. BNP's synthetic trading activity on A-shares has been fairly evenly split between p-notes and equity swaps, he added.
Hong Kong, which serves as a regional hub for many banks, is home to Asia-Pacific's most active OTC equity derivatives market, accounting for around 34 percent of regional turnover with a notional value of roughly $1 trillion, according to end-2012 data published last year by consultancy Celent. Information on China A-share equity derivatives was not available.
Data on p-note activity in Hong Kong is not available, so it is difficult to assess the size of the market, but by comparison the value of outstanding p-note investments in India - where such products are also actively traded by foreign investors - stood at around $40 billion in October.
China stocks have soared more than 25 percent over the past five weeks, driven by a surprise cut in interest rates on Nov. 21, but trading has been volatile, with the Shanghai Composite Index posting its biggest one-day fall in 5 years on Dec. 9.
Concerns that the OTC grey market might exacerbate such volatility are not Beijing's only worry.
Synthetic equity products do not typically confer ownership or voting rights to the end investor, a critical means of boosting corporate governance among China companies, said Sally Wong, chief executive of the Hong Kong Investment Funds Association.
She added: "For the mainland regulators, a key objective of Stock Connect is to diversify the investor base with the ultimate objective of boosting corporate governance."