is an inherent contradiction in China’s position
among the world’s biggest producers and consumers
of many metals — while prices are still set in the
traditional trading centres of the London Metal Exchange and
New York Mercantile Exchange.
isn’t China the price discovery home for these
short answer is regulation.
is often an enormous amount of red tape to be dealt with in the
country. Listing a new contract, for example, in theory
requires a simple approval by the Chinese Securities Regulatory
Commission. But, in practice, the process is more convoluted.
The CSRC will not approve a product unless a consensus has been
formed by the State Council and almost any ministry or
commission that might have some interest in the product.
long answer is more subtle. Regulatory change in China is
working to a different pace — and a much more
deliberate tread — than the hectic rate Western
markets demand as normal.
participation in China’s financial markets is
restricted. There is a limited entry gate, through the
Qualified Foreign Institutional Investor programme.
This was launched in 2002 to allow licensed foreign investors
to buy and sell renminbi-denominated 'A’ shares
listed on China’s mainland stock
26, for the first time, the Chinese authorities permitted QFIIs
to trade in Chinese derivatives. The decision, which had been
widely predicted, came sooner than expected, after a US-Chinese
Strategic and Economic Dialogue meeting in Beijing.
market participants had forecast, QFIIs are only allowed to use
the new CSI 300 Index Futures at the China Financial Futures
Exchange — not commodity derivatives. And no start
date has been announced for the new policy.
more complex method of entry for foreign companies is to
acquire a Chinese trading firm. However, the foreign stake may
not exceed 49%.
commodities, non-Chinese firms — even QFIIs —
are still barred from the three commodity futures markets of
Dalian, Shanghai and Zhengzhou.
result, Emmanuel Faure, head of business development and sales
for futures at HSBC in Hong Kong, describes the Chinese futures
market as "purely a domestic market — albeit a very
the main reason why the benchmark prices for goods such as
copper, aluminium and oil are still set in London and New
Benchmarks will move
present state of affairs is unlikely to last forever. Futures
specialists say that if the Chinese government and the CSRC do
decide to allow international participation, commodity price
benchmarks will shift east. "Given China’s large
consumption of raw materials, it is likely that benchmarks will
emanate from China," says Nicholas Forgan, head of JP
Morgan’s futures and options business in Asia
Pacific and chairman of the Futures Industry Association in
Asia – although he says it is difficult to predict
when that shift will begin.
Dean Owen, chief China representative of futures broker Newedge
in Shanghai, says the CSRC believes that allowing international
players into its commodity markets would be beneficial. It is
just taking its time.
and exchanges in China understand the arguments for a
diversified client pool, which includes the participation of
domestic as well as foreign investors," says Owen. "But China
does not have a habit of doing things in a big bang, they do
things in stages. It will be progressive and
every one is so confident. TieCheng Yang, foreign legal
consultant and partner at Clifford Chance in Beijing, has
extensive experience of China’s financial, equity
and commodity derivatives. He believes a move to open commodity
markets to foreign players is improbable, as unlike with
financial derivatives, foreign firms are not active in the
want change in China, however, there is plenty going on.
Despite its three commodity exchanges, now among the
world’s largest, China has for the past decade
lacked any listed financial derivatives — until
country made its first move in this direction in 2006 with the
launch of the China Financial Futures Exchange. This was a
joint venture between the three commodity exchanges and the
stock exchanges of Shanghai and Shenzhen.
first intention was to launch futures on a stockmarket index.
But as the years passed, eagerness for the contract gave way to
scepticism that anything would ever happen.
all changed in January when the CSRC announced in a curt
statement on its website that CSI 300 Index Futures had been
approved for launch at the CFFEX. The CSI 300 is the most
followed index of 300 leading stocks in Shanghai and
was a mixed reaction to the news. Some thought it was yet more
proof of the slowness of change in China — given that
the contract had first been proposed nearly a decade before.
Owen took the opposite view, believing that the timing of the
listing was "perfect".
Only for the few
again, regulatory barriers around the market are high, so that
only what the authorities regard as the right sort of market
participant can use the contract.
frightens them, China-watchers believe, is the possibility of
seen the huge run-ups and crashes in Chinese stocks this
decade, the authorities are very anxious not to make matters
worse. Index futures, they hope, will be used mainly by hedgers
rather than speculators.
only Chinese firms (and, from an as yet unspecified date,
QFIIs) are eligible, and even for them it is costly. Every
retail investor is required to pay a Rmb500,000 ($73,000)
deposit. Yet, according to the China Securities Depository and
Clearing Co, less than 3% of investors in 'A’
shares have that much money in their trading accounts. This
means the vast majority of retail investors are unlikely to
have the resources to trade in index futures.
addition, trading is done on pre-margin at a rate of about 15%
the contract value, which is calculated from the CSI 300 index
(currently fluctuating around the 3,000 mark) multiplied by
Rmb300. (The actual margin is 12% but broker fees increase the
figure to 15%-20%.)
the index at 3,000 this means a single contract is worth
Rmb900,000 ($132,000). Compare that with about Eu25,000 for a
Euro Stoxx 50 Futures contract at Eurex.
this equates to a margin of Rmb135,000 per contract in a
country where the average annual urban income is less than
Rmb40,000 and some half a billion people still live in the
Blaze of activity
restrictions on the new index futures are so tough that some
observers expected a damp start to trading. They
couldn’t have been more wrong.
contract went live on April 16 and immediately enjoyed
substantial success. Trading on the first day totalled 58,500
lots. The following day volume was 124,000 contracts, the next
says that after just two days, the contract had proved a
success. As he puts it: "The volume on the first day was good,
the volume on the second day was extraordinary."
first five days of trading, FOW estimated, the notional value
of contracts traded amounted to roughly Rmb572bn
comparison, in March, the Euro Stoxx 50 Index Futures contract
at Eurex traded an average of Eu39.6bn ($53bn) a day. That
means that in its first week, the new Chinese contract was
already trading, in cash terms, about a third as much as the
Euro Stoxx 50.
21, as this article was completed, the cash volume in CSI 300
Futures was almost 40% of the volume in Euro Stoxx 50
clear that the CSI 300 is already one of the
world’s most important equity index
Door creaks open
QFIIs remain excluded from Chinese derivatives, the door may
soon be opened, though only for the new CSI 300 contract
— and even then only to hedge exposure that each firm
may have in the underlying 'A’ share
to discussions between the regulators and the QFIIs, foreign
participants will be given a quota to trade the new CSI 300
futures," says Yang.
no specific figure has been floated, the number of trades the
QFII will be allowed to execute will be a percentage of its
existing quota permitted by the CSRC.
says it is too early to say when this relaxation might happen,
though other market participants believe it could come this
market participants were taken by surprise when the Chinese and
US economic delegations’ joint statement on May 26
will permit qualified foreign-invested firms duly incorporated
in China to carry out stock index futures business in
accordance with relevant laws and regulations and will allow
QFFIs to invest in stock index futures products."
from the timing, however, the decision had been expected. The
CSRC had in April issued draft guidelines for letting QFIIs
into the index futures market. These suggest that QFIIs will
only be allowed to use the futures for hedging 'A’
share positions, though it is not clear what kind of positions
may be hedged.
It is also unclear how many
contracts foreign firms will be able to engage in. "The index
futures contract value shall not exceed the approved QFII quota
on the end of each trading day," read one condition of the CSRC
proposal, while the third read: "The index futures contract
value shall not exceed the entire investment quota on the end
of each trading day."
Commodity exchanges smash record after
China discovered derivatives in a big way in the early
1990s. In fact, too big a way. N
ew exchanges — some 20 in all — were
opened with wild abandon. But instead of the new
financial products being used for hedging risk, they
were used as speculative tools. The result: frenzied
growth was accompanied by rampant abuse.
And with abuse came the inevitable clampdown by
China Securities Regulatory Commission. The result was
that, until very recently, there were only three
authorised exchanges — all state-owned
— and the number of permitted contracts was
The three survivors — the Zhengzhou Commodity
Exchange, Shanghai Futures Exchange and Dalian
Commodity Exchange — each offer a different
portfolio of commodity futures.
Until recently, the SFE was China’s
smallest commodity exchange. That changed when it
introduced its Steel Rebar (reinforcing bar) contract
at the end of March 2009.
This proved so successful that SFE has become the
country’s largest exchange. From launch
until the end of 2009 the contract notched up some 162m
trades, making it the most successful new futures
contract launch ever. Apart from the tiny Nasdaq OMX
Futures Exchange, SFE was the world’s
fastest growing exchange in 2009, with volume expanding
The second largest exchange is the agriculture-focused
DCE, where volumes have grown steadily since the early
2000s. In 2009, the exchange hosted trading of 383m
contracts, 31% up from 293m the year before. The
exchange’s flagship contracts are Soy Meal
Futures and Crude Soybean Oil Futures.
The big success story for the DCE last year was the
launch of its Polyvinyl Chloride Future at the end of
May which, with a volume of 16.8m contracts last year,
was the second most successful new contract introduced
worldwide in 2009.
Volume at the ZCE ticked up only slightly in 2009, from
223m contracts in 2008 to 227m. The volume was
supported by White Sugar Futures, which have dominated
activity since the exchange started. Last year ZCE
launched its Long Grain Rice Futures contract. Its
annual volume of 1.95m contracts made it the
world’s best performing agriculture
derivative introduced during 2009.
New products and rising volumes of trades propelled all
three exchanges into the top 20 largest exchanges by
annual trading volumes last year. SFE was the biggest
climber, moving from 24th to 12th, while DCE climbed
from 15th to 14th. The ZCE, despite an increase in
trading volumes, slipped one place to 18th.
The quota will be decided by the
State Administration of Foreign Finance, but market
participants do not know whether these conditions refer to
existing 'A’ share quotas or whether the
authorities will impose a separate futures limit.
Owen believes the impact of the
QFII participation on trading volumes will depend on this
quota. "The existing total QFII quota is less than $20bn, so if
the futures limit is a percentage of that then I
wouldn’t expect it to have too much of an impact
on trading volumes," he says.
While volumes in CSI 300 futures
are soaring, the pattern of open interest suggests there is a
lot of intraday trading.
Market commentators have suggested
that Chinese traders may have adopted this approach because of
the lack of hedging tools to hedge overnight movements in
Owen believes QFII
firms’ involvement could raise open interest.
the US had pushed for the regulatory change, none of the 95
registered QFII firms headquartered in the US will be able to
trade the index contact until the Commodity Futures Trading
Commission gives its clearance.
US law, foreign boards of trade that wish to permit their US
members and other participants in the country to have direct
access to their electronic trade matching systems, not through
an intermediary, must request no-action relief from the
CFTC’s Division of Market Oversight.
believes there is little chance that other foreign
participants, besides QFIIs, will get access to the futures
market, partly because the government is wary of firms such as
hedge funds being active in its markets. Owen, too, warns
against expecting any rapid liberalisation of the rules
A steady course
conservative and considered approach to its commodity
derivatives markets — and now its financial futures
— may help it avoid the excesses that so damaged its
exchange-traded derivatives industry in the 1990s.
says it is clear that Chinese regulators have not been
preoccupied with growing volumes, but rather with nurturing the
market’s development. "Other exchanges worldwide
seem to solely focus on generating volume, but that clearly
isn’t the case for China," he says. "Here, their
main concern is to minimise the systemic risk that could impact
the stable development of the financial industry, and to ensure
that the investors are well educated and aware of the risks
involved in dealing with derivatives."
own timetable of making Shanghai a global financial centre by
2020 shows that the country is playing a long game. Likewise,
its slowly-slowly method of expanding participation in the new
equity index future by QFIIs is described as the "next logical
step" by one market participant.
and orderly is the name of the game,"
agrees Forgan. "I expect the opening of the market to be
staggered," beginning with the introduction of foreign
those foreign firms will find when they finally enter the
Chinese exchanges is an already hugely liquid market.
"We’ve already seen some enormous volumes go
through on the domestic markets – steel would be a
great example of this," says Forgan. "Liquidity is provided by
a large retail market, and an institutional market which is
interested in becoming more active in derivatives."
Few involved in China have any doubt where it is all leading in
In Faure’s words: "China is going to be the number
one ranked country by trading volume in Asia, and most likely
number one in the world, in a comparatively short period of