China’s derivatives markets are still a closed shop for many foreign investors despite gradual shifts in the local regulatory regime, which have seen access to stock index futures broaden in contrast to continued restrictions on non-domestic commodities trading.
In May, the China Securities Regulatory Commission issued guidelines that permit firms with qualified foreign institutional investor (QFII) status to trade stock index futures. The guidelines state that QFIIs may only trade stock futures in China for hedging purposes and must abide by strict limits on daily volumes. The only official stock index future traded in China is the CSI 300, based on the A-shares of the 300 largest corporates listed in Shanghai and Shenzhen, which trades on the China Financial Futures Exchange.
However, achieving QFII status is far from a given. By the end of Q3 2010, investments of around US$ 20 billion made by just under 100 QFIIs had been approved by China’s foreign currency regulator; around 10 additional QFII licences have been granted since. While guidelines for acquiring a QFII licence exist, they are subject to interpretation.
“There are stringent criteria, and there’s no guarantee you’ll be approved,” said Dean Owen, chief representative and SVP, China, at multi-asset brokerage firm Newedge. “QFIIs have to be of sound financial and credit status with minimum amounts of net assets and years in existence depending upon investor type. It’s not an easy way in.”
Moreover, firms that have achieved QFII status continue to face multiple restrictions on their trading and investment activity, including quotas limiting the amount of Chinese securities each QIFII is allowed to purchase. Arbitrage is not permitted, while short selling in China can be characterised as “tricky, difficult and expensive”, according to Nick Ronalds, executive director for the Futures industry Association (FIA) in Asia, speaking on a webcast last month, hosted by trading technology provider RTS RealTime Systems.
Newedge’s Owen pointed out that the early daily closing of the Shenzhen and Shanghai exchanges posed a further difficulty. “Once the Chinese market closes for the day at around 3pm, there is nothing to hedge your position against,” he said. “Investors are wary of taking large overnight positions as they don’t want to wake up to massive losses caused by large overnight moves in the US and Europe. There is nothing anyone can do about it, and people just don’t want that level of overnight risk.”
But there are an increasing number of ways for non-domestic market participants to achieve China exposures via synthetic means. Citing exchange-traded funds listed in Hong Kong and Singapore as an example, Owen suggested that FTSE China A50 listed futures available in Singapore could provide a useful entry-point for foreign institutional investors.
“Volume is growing,” he said. “For August the volume was around 13,000 contracts, up 20% on the month before. The FTSE China A50, listed in Singapore, constitutes an easy way to trade China.”
Previously part of the FTSE Xinhua Index Series, the FTSE China A50 Index is a real-time index comprising the 50 largest 50 A-Share companies by full market capitalisation. The index includes stocks listed on the Shanghai and Shenzhen stock exchanges and is updated on an intra-second basis.
Access to Chinese stock index futures might be restrictive, but non-Chinese firms are confronted with much more serious obstacles in trading commodities futures. Effectively, foreign firms must establish local incorporated entities with legitimate business justifications for accessing China’s commodities markets. This has led to non-domestic prop trading firms and other financial institutions exploring the potential for establishing a physical commodities trading presence.
And while OTC derivatives markets in China do exist, many operate in a state of uncertainty due to their position in Chinese law. “There are no legal OTC commodity markets in China,” said Ronalds at FIA Asia. “Spot markets exist that allow the rolling of positions, creating a de facto forward market. There is a financial OTC market, but it is not very big or liquid.” Ronalds estimates that the largest section of China’s OTC market, the currency swaps market, trades a notional RMB 5 billion on an annual basis, worth approximately US$600 million – by global standards, not a huge market.
Sometimes imperceptibly, China’s regulatory framework continues to evolve to allow greater cross-border activity. The CSRC has moved to approve a select number of domestic brokers in China with an out-bound agency licence, greatly improving their access to the outside world. Regulators are looking to open up markets to broader participation by trust companies and securities companies, with banks already allowed into the listed derivatives market on certain contracts such as gold, for example.
But despite the development of co-location services at some exchanges, it is likely to be some time before high-frequency trading (HFT) becomes a significant presence in China. With many would-be foreign market participants more concerned about access at present and with the vast bulk of local trading done by the Internet in any case, low latency is not a priority. “The majority is about reach and connectivity to the exchanges, it is not yet about HFT and low-latency,” added Steffen Gemuenden, CEO of RTS. Margin costs and official concerns over price volatility further reduce scope for increased levels of HFT in the immediate future. “The market is just not conducive to HFT at the moment,” said Owen.