On 1 August 2022, China's Futures and Derivatives Law came into force, introducing a comprehensive regulatory framework for the trading, settlement and clearing of futures and derivatives. Over the last six months, the China Securities Regulatory Commission (CSRC) has issued several draft regulations for consultation aimed at implementing requirements of the law and enhancing, among other things, the risk management systems of futures exchanges and strengthening legal protections for investors.
"These [latest draft] rules seek to refine and update regulatory requirements on market participants," says Chin-Chong Liew, partner at Linklaters. "In addition to implementing specific changes brought about by the Futures and Derivatives Law, these rules intend to codify certain best practices in China's futures market and to align with international standards. These rules also provide a regulatory framework for certain new products and services in China's futures market," he tells MarketVoice.
Here, we provide a summary of the CSRC's draft regulations as well as recent developments in China to open up its derivatives markets further to international investors.
Rules for futures exchanges (in force)
The CSRC introduced revised rules for futures exchanges, which establish a unified framework and lay down common requirements to be adopted by all futures exchanges established in China.
The revised measures, which came into effect on 1 May, set out rules that align with and implement various requirements of the Futures and Derivatives Law, including the central counterparty role played by exchanges, margin enforcement and default management measures, and the segregation of futures margins and positions.
The new requirements also cover product listings, programmatic trading and account management – requiring the identification of persons with the ‘actual control relationship’ and for reporting systems for programmatic transactions to be enhanced.
The rules also introduce requirements for futures exchanges seeking to implement a market maker system for futures trading, standardise the mechanism for cross-border cooperation of futures exchanges, and allow futures exchanges to carry out settlement price authorisation business.
They also set out requirements on the internal governance of a futures exchange, requiring each to establish risk management committees and product listing review committees, and to enhance the role of general meetings and the board of directors in governance.
Exchange rules on position management (draft)
In January, the CSRC proposed new rules that would empower futures exchanges to impose position limits and reporting requirements on market participants.
The proposed rules direct futures exchange to formulate, adjust and regularly evaluate position limits – including for arbitrage and market-making transactions – taking into account factors such as the futures and spot market size, market structure, market concentration, and available delivery volume. Futures exchanges will be able to impose position limits for products individually or jointly.
Participants can apply for exemption from position limits requirements for hedging and other futures trading activities conducted purely for risk management purposes.
Futures exchanges are also required to establish a large trader position reporting system. Reporting standards may be adjusted based on changing market risk conditions, and report content may include information about traders' participation in domestic and foreign futures markets, OTC derivatives markets and spot markets, the CSRC said.
The draft rules are published here. FIA has expressed support for the measures.
Rules for futures companies (draft)
In April, the CSRC issued draft amended regulatory measures for futures companies, which aim to expand the scope of business activities that future companies are allowed to conduct directly.
Under the current regime, outlined by the Regulatory Measures for Futures Companies (2019), the typical business scope of a futures company is commodity futures brokerage. Businesses with perceived higher risks – such as financial futures brokerage, offshore futures brokerage, and futures consultancy – are subject to the CSRC's separate approval and required to be carried via special purpose subsidiaries.
With the coming into force of the Futures and Derivatives Law, which expressly permits direct involvement of futures companies in futures brokerage (both commodity and financial futures), futures trading consultancy and market making activities, the 2019 Regulatory Measures will be amended and updated to align with the law.
The amended measures, however, do not address topics related to offshore futures brokerage and foreign futures exchanges operating onshore. The CSRC says in an explanatory notice that such topics require further research and analysis.
Rules for futures practitioners (draft)
In April, the CSRC issued draft rules for futures market practitioners, which cancel qualification management requirements, strengthen supervision and self-discipline requirements, and expand the range of prohibited behaviours.
The rules seek to improve practice standards by improving the "moral standards, professional capabilities, compliance risk awareness and integrity" of futures practitioners. A wider range of behaviours are prohibited under the new rules, including the private acceptance of client funds to engage in futures transactions. Futures practitioners are generally prohibited from engaging in futures transactions under a pseudonym or in the name of other individuals.
The draft rules are published here.
Rules for hosted trading facilities (draft)
In April, the CSRC issued draft rules on the hosting of facilities to support trading services in China's securities and futures markets, including trading server colocation.
The facilities refer to the communication networks, software or hardware facilities and other resources provided by securities and futures exchanges, as well as the information systems deployed for securities and futures firms to connect to markets.
The rules are intended to address issues such as inconsistent line latency and the need to enhance security capabilities. They also require exchanges to follow principles of safety and fairness and impose notification requirements to regulators and other relevant agencies "in a timely manner to prevent and resolve potential risks."
The draft rules are published here.
Rules on OTC derivatives trading (draft)
In March 2023, the CSRC published a consultation draft of the Administrative Measures for the Supervision of Derivatives Trading. The draft measures are the first set of comprehensive regulations for the supervision of the OTC derivatives market in China.
The draft measures apply to OTC derivatives trading activities of CSRC-regulated securities companies, futures companies and their onshore subsidiaries and OTC derivatives trading organised by securities and futures exchanges. The China interbank derivatives markets (comprising interest rate, FX and credit derivatives) are outside the scope of the draft measures.
The rules cover trading and settlement, prohibited trading activities, supervision of traders and intermediaries, and market infrastructure, among other areas. The rules clarify that the CSRC can implement position limits and large account position reporting systems for derivatives transactions, based on regulatory needs. Those engaged in hedging activities will be able to apply for position limit exemptions.
The rules also implement a derivatives transaction reporting system, introduce new supervision standards for the market, and allow firms to engage in cross-border derivatives trading business, subject to the CSRC's approval.
The draft rules are published here.
Enhanced rules for stock options trading (draft)
In December 2022, the CSRC updated its rules for stock options trading on Chinese exchanges, ending the 'pilot' status of the programme. The revisions implement additional requirements for the registration and listing of options contract varieties and clarify the central counterparty status of ChinaClear in stock options trading.
The rules also improve the business scope of futures companies, allowing them to engage in stock option brokerage business and conduct market-making activities for stock options.
Stock exchanges are required to improve their risk management through the establishment of a hedging management system and by collecting data on traders' positions and margins.
The draft rules are published here.
Swap Connect launch
In other recent developments, the northbound trading of Swap Connect launched in Hong Kong on 15 May, giving global investors their first access to the mainland China interbank financial derivatives market to hedge the interest rate risks of their Chinese bond holdings. The new scheme marks another milestone in the gradual opening up of mainland China's financial markets.
Previously, offshore investors used non-deliverable interest rate swaps to hedge against interest rate risks of their underlying China bond positions. As there are fewer dealers in Hong Kong that offer such instruments, offshore investors often face a heftier hedging cost than onshore counterparts.
Under the new programme, offshore investors are now able to use Tradeweb or Bloomberg to access the CNY interest rate swap liquidity pool, as they currently do for Bond Connect. Foreign investors face HKEX's derivatives clearing house, OTC Clear, while onshore counterparties to the trades face the Shanghai Clearing House.
The daily trading cap for Swap Connect is set at 20 billion yuan for the entire scheme after netting, while the clearing limit is set at 4 billion yuan after netting between OTCC and SCH. The quotas will be adjustable in the future, depending on market conditions. On the first day of the programme's launch, 27 offshore investors traded onshore RMB interest rate swaps with a notional value exceeding RMB 8,259 million.
Swap Connect will be further expanded in the future to allow China's market participants to participate in the Hong Kong OTC derivatives market ("Southbound" trading).
In September 2022, China's five major futures exchanges further opened domestic futures and options contracts to Qualified Foreign Investors (QFIs) as part of efforts to deepen the country's global pricing power in commodities.
Separately, at the start of this year, China's Zhengzhou Commodity Exchange opened futures and options in rapeseed oil, rapeseed meal and peanut kernel to international traders less than a month after the Dalian Commodity Exchange opened its entire soy complex to international trading.
Chinese regulators have said they plan to open more futures products to foreign investors this year.