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China opens futures markets further to outside world

Sixth international commodity futures contract launches in China as barriers are lowered for overseas investors

25 November 2020

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China's drive to open its futures markets to the outside world gathered pace in November when new rules making it easier for international investors to trade in China’s markets came into force. In addition, a copper futures contract, tipped to become a key benchmark, launched in Shanghai while the China Securities Regulatory Commission announced that international trading of palm oil futures contracts would begin in December.

The new rules, which went into effect on 1 November, replace the schemes that governed foreign access to the country’s onshore capital markets – the Qualified Foreign Institutional Investor scheme and its yuan-denominated sibling RQFII – with a unified qualified foreign investor regime.

The new rules simplify and speed up the process through which international investors can apply for a license to access Chinese markets. They also expand the categories of products in which a QFI can invest.

Under the previous regime, foreign funds could invest in stock index futures. Under the new regime, the range of accessible products will be expanded to include bond futures listed on the China Financial Futures Exchange and commodity futures and options traded on exchanges in Dalian, Shanghai and Zhengzhou.

Half a dozen commodity futures are already open to direct participation by international investors, including crude oil and iron ore futures. Chin-Chong Liew, a partner in the Hong Kong office of law firm Linklaters, expects these futures contracts will likely be among the first batch of futures products opened up to QFIs.

Speaking on 10 November on a webinar hosted by FIA and Linklaters on China’s Latest Steps to Open its Markets, he said: "While the exact scope of these products will be announced in the weeks ahead, we understand that they will be made available in phases. The first phase will be those commodity products already available under direct access, plus a couple more which are more liquid, and then more will become available later in phase two."

Fast track for QFI licenses

Under the new rules, the eligibility criteria has been relaxed and several quantitative criteria, such as the minimum term of operation and size of assets under management, have been removed, meaning a wider range of market participants can apply to become QFIs, John Xu, a partner in the Shanghai office of Linklaters, said on the webinar.

The application process has also been streamlined and electronic filing has been enabled. In addition, the CSRC has committed to a shorter review period of 10 working days to decide whether to grant a QFI license, down from 20 days previously.

The new rules also enable QFIs to appoint multiple onshore custodians, as well as onshore futures brokers and exchange clearing members.

"An issue from a legal perspective is, are we protected because QFIs will be giving margin to the broker who then hands it over to the CCP in the futures exchange. The good thing to note is that under Chinese law, margin always belongs to the provider, so the QFI is protected," said Liew.  

With the broadened investment scope, the new rules also reinforce corresponding compliance obligations, including more transparency of QFIs' investment activities for regulators. For example, the CSRC has the right to require a QFI to report information on its offshore hedging positions and other information related to its securities and futures investment in China.

"Under the QFI regime, the theme is very much of opening up and allowing easier access for QFIs," Liew said. "It really is a high point of openness and capital market development for China."

Copper futures

In another major development, foreign participants began trading bonded copper futures on the Shanghai International Energy Exchange on 19 November. This is the sixth contract opened to direct access by foreign entities.

The move to internationalise existing contracts or launch new ones is part of China's goal to strengthen its pricing power in the commodities markets it dominates. In the non-ferrous metal market, China is the largest consumer of copper, accounting for more than half the world’s consumption of the metal, which is used in everything from electronics to construction.

China also wants to expand the use of the yuan for transactions overseas, part of a long-term strategy to raise the profile and influence of the currency. At the same time, the government wants domestic companies to be able to hedge more against volatility. Allowing foreigners to trade these contracts goes some way towards achieving its ambitions.

China already has a copper futures contract listed on the Shanghai Futures Exchange, but foreign entities need to set up a local company to use it. The one listed on SHFE's subsidiary INE provides foreign entities with direct access to a contract that is identical to SHFE copper futures in terms of size and price quotation units, but it excludes value-added tax, making it similar to international prices.

While the contract is settled in yuan, investors using an overseas intermediary can use dollars for the initial margin. The product also will be delivered into so-called bonded warehouses, which are outside the customs area and free from import duties and taxes. This will help it to compete with the London Metal Exchange, which is owned by Hong Kong Exchanges and Clearing and has no warehouses on the mainland.

At present, the international copper pricing benchmark is the LME contract, denominated in dollars, but some analysts say the INE contract could also eventually become a key benchmark.

"This contract makes a lot of sense, and we see it as having a high chance of being extremely successful, given over 70% of copper consumption is now in Asia, plus there is more material available in the China bonded zone than on the LME. As such, we see this as the market of last resort for purchasers," said Colin Hamilton, managing director, commodities research at BMO Capital Markets. 

"We would expect this contract to become a key benchmark for global copper once liquidity increases, provided international market participants can gain confidence in the delivery systems, tax implications and RMB exposure," Hamilton told MarketVoice.

UK-based brokerage Sucden Financial said it was one of the first overseas companies to trade the contract supported by overseas intermediary Bands Financial. INE also announced 15 market makers for the product, including units of China Minmetals Corp. and Chinese brokerage CITIC Securities.

Agricultural futures

China has so far internationalized six commodity futures contracts. The first was a yuan-denominated crude oil contract, launched in March 2018 on INE. This has been relatively successful, having attracted interest from foreign traders, but volumes are still well below those of Brent and West Texas Intermediate.

Next China opened up its existing iron ore contract on the Dalian Commodity Exchange to foreign participants and in doing so established a global benchmark. The other contracts are TSR 20 rubber and low-sulphur fuel oil listed on INE, and purified terephthalic acid on the Zhengzhou Commodity Exchange.

Starting from 22 December, foreign investors will also be able to trade palm olein futures on the DCE, the CSRC announced on 20 November. China is the world’s second-largest importer and the third largest consumer of palm oil.

"Market participants generally share the view that RBD palm olein futures, after being open to overseas traders, will be DCE’s first agricultural futures product to open up to the world," the exchange said. "As a significant step in the internationalization of China’s futures market, it will further improve the ability and level of China’s futures market to serve the global industrial chain."

A senior DCE official told the FIA Asia conference last year that the exchange is also working to open up its soybean futures contracts.

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