The Futures Market in China
By Mick Zomnir
China’s futures markets began with the trading of commodities futures in 1990 and experienced a quick and steady expansion until the middle of the decade, when loopholes in the regulatory scheme led to problems of fraud and extreme speculation. At that time, a variety of scandals forced the Chinese authorities to clean up the country’s financial markets. Many futures exchanges and brokerages were closed, and various financial products were suspended from trading. Ultimately, China shut down its bond futures market and prohibited trading of financial derivatives, restricting China’s exchanges to handling commodities futures.
Today, futures trading in China remains limited to commodities. Trading takes place at China’s three commodities exchanges in Shanghai, Zhengzhou, and Dailan.
With the establishment of the China Financial Futures Exchange (CFFEX) in Shanghai in September, 2006, Chinese authorities took a major step towards creating a modern financial futures market. However, activity to date has been limited to mock trading, with no money trades yet authorized for CFFEX.
The first product created by the CFFEX is the CSI300 index, which includes the 300 largest A share companies listed on the Shanghai and Shenzhen Stock Exchanges. While the CFFEX plans to introduce more financial derivatives, including index, government bond and currency futures, no specific dates for the introduction of these products have been set. Likewise there is no specific timetable for the commencement of real money trading on CFFEX.
The Chinese authorities have made it clear that their goal is to have sufficient transparency in China’s capital markets, including futures trading, so as to limit speculation and avoid volatility shocks. For example, China requires banks to disclose to regulators the details of trades in Yuan-denominated derivatives, either by funneling activity onto an exchange or by electronically registering deals after they are executed. This requirement, which makes China unique among major economies, has placed Chinese regulators in a better position to monitor the scale of trading and to clamp down on risky behavior.
In 2008, China used data on commodities futures to unwind a messy set of copper trades. When China first introduced its trade disclosure requirements, they were criticized by many in the West as being “big brotherly” in nature. In the wake of the global financial crisis, Western regulators would like to have such information for their own financial markets.
For clearing and settlement, CFFEX uses a multi-tiered clearing system that is popular in many overseas markets. Under this system, CFFEX categorizes its members as trading members, trading and clearing members, general clearing members and special clearing members according to their respective risk
tolerances. Members in the four tiers have different business scopes, a fact that enables the construction of a multi-tiered risk control system.
China’s three commodities exchanges in Shanghai, Dailan and Zhengzhou are “non profit-seeking incorporated bodies” regulated by the China Securities Regulatory Commission. CFFEX, in turn, is a joint venture between all three of China’s commodities exchanges and its two major stock exchanges in Shanghai and Shenzhen.
The organizational structure of CFFEX is similar to that of a corporation so as to improve its competitiveness and development potential, while implementing strict risk management policies to ensure its institutional vitality. CFFEX’s shareholders’ meeting is its “organ of power,” and its Board of Directors exercises the power conferred by that meeting. The CFFEX board of directors appoints an executive committee to carry out the day-to-day functions of decision-making, management and enforcement.
China has been understandably cautious in developing its futures markets. The CFFEX has been created to act as a testing ground for financial futures through mock trading and will become China’s first financial futures exchange. While the global financial crisis has slowed this process, it has by no means halted it. In my next article, I’ll discuss some of the main themes for the development of China’s futures markets that were discussed by the experts at the Institutional Investor’s Third Annual China Investment Management Summit.