Top China official shares outlook for derivatives markets

FIA hosts fireside chat with Vice Chairman Fang Xinghai of the China Securities Regulatory Commission

14 December 2020


FIA President and CEO Walt Lukken sat down with Vice Chairman Fang Xinghai of the China Securities Regulatory Commission for a discussion on the development and opening-up of China's futures markets as part of the FIA Asia-V conference on 1 December.

Below is a lightly edited transcript of their conversation:


Walt Lukken: Tell me a little bit about your background. How does one become vice chairman of the CSRC?

Fang Xinghai: Well, you know, one cannot always plan every detail of his career. I started out as an investment officer at the International Finance Corporation in the World Bank. And in that position, I actually worked on a number of projects in capital markets in the developing countries such as Indonesia and India. Then upon my return to China, I went to work for the Shanghai Stock Exchange for five years. Although the stock exchange was mostly a cash market and it is still mostly a cash market, the Shanghai Stock Exchange has a growing derivatives business nowadays.

Then after a few years, I went to work for the Shanghai government. My job there was responsible for building Shanghai into an international financial center. And by the way it is flourishing at this point. It was ranked number three just this year in terms of international financial center rankings, right behind London and New York.

In 2013, I was called upon by our central government to come to Beijing and work as director for the international economic bureau in a special office. The formal name is actually quite long. It's called the Office of the Central Leading Group for Financial and Economic Affairs. The closest counterpart in the US government system that I can think of is the National Economic Council at the White House. And I was in that position for about three years.

At the end of 2015, I was appointed as vice chairman of the CSRC, the China Securities Regulatory Commission. And as you know in China, futures market regulation and stock market regulation are combined into one institution, which is the CSRC.

Since early 2016 my responsibility within the CSRC has been overseeing the futures markets. Among other things I'm also responsible for corporate finance. But I've been watching over the futures market at the CSRC for the last five years.

And I have enjoyed it thoroughly. I'm happy to report that the futures market in China has been growing quite nicely over the last five years. And it also runs smoothly. We haven't had a major incident, a major breakout of financial risk or anything like that, over the last five years. So I'm quite pleased with the progress we are making.


WL: It sounds like the position you had right before the CSRC that you mentioned, which was akin to the National Economic Council, was a very important position. I'm sure that gave you great experience to get to your current position at the CSRC.

FX: I did have a great opportunity in that position to work with various counterparts in the US. The NEC, and even the National Security Council as well in terms of international economic relations. And I remember I participated in a negotiation of the bilateral investment treaty with the US that we almost finished at the end of the Obama administration. But as you know, everything was stopped after that.


WL: Well, let's talk a little bit about the priorities of the CSRC. You were making great strides in opening the markets, but we did run into a pandemic that has affected the global economy. As a result, the priorities of market regulators have shifted. How has the pandemic shifted your priorities at the CSRC?

FX:  Well, contrary to the situations in some other countries, the pandemic in China hasn't had a major impact on the direction of the capital markets. If anything, it has accelerated the pace of development as well as reform and opening-up in the Chinese capital markets.

Now, of course, when the pandemic broke out in January right after the Chinese New Year, we resumed the operation of the market. And then we had to wear masks everywhere. Some people have to work remotely from their home, but other than that, everything else moved according to the plan.

For example, one of the major reform projects this year in the Chinese capital market was to implement what we call the registration system for IPOs on the so-called ChiNext market of Shenzhen Stock Exchange. And that went along according to the plan. So that was done in August this year and the pace of IPOs has actually accelerated this year. This year we are looking at almost 400 IPOs in the Chinese stock market. And in terms of capital raised, we will set a new historical record in the Chinese market.

The secondary market trading has been active as well. And in the futures market, trading volumes as well as contracts outstanding have all gone up significantly.

And that is not surprising. If you think about the role of a futures market, it is there to discover price and then manage risk. And when the pandemic hit, it actually created a lot of uncertainties in the economy. And firms and investors would like to respond to what is going on. So we have seen more investors coming into the futures market just to manage the risks.

And so we are very pleased to see that the futures market in China has played the role that it is supposed to play. That is, to smooth out the economic fluctuations and to make risk management easier. So overall the capital markets in China as well as the broader financial markets in China have played this critical role of enabling the economy to recover quickly from the hit of the pandemic. So, if you talk about the almost V-shaped recovery in China in our economy, I think the financial markets and most specifically the futures market in China has played a critical role.


WL: That's wonderful news to hear. I know a year ago, when we talked at your CSRC international advisory council meeting, one of the concerns in China was trying to get more wholesale institutional participants in the futures markets. It sounds like that has been accomplished through a variety of ways over the last year, or at least you're making strides in that direction. Tell me a little bit about some of those efforts

FX: Well, China has a lot of savings, right? So we have a lot of retail investors in our capital markets. That is true in the stock market and it is also true in the futures market, but as you know, retail investors do not help create a high-quality market. They tend to come in and leave at the same time. That creates a lot of volatilities. So both in the stock market as well as the futures market, we have been pursuing a strategy of attracting more institutional investors.

In the futures market, we've seen quite a bit success, but we are still not fully there yet. In terms of domestic institutions and investors, we now see a lot more participation by what we call "real economy" firms -- the firms that are in manufacturing, in mining, in providing services, all these real sectors. We have seen a lot more of these firms because they increasingly feel the need to manage risk.

And previously when the quality of the market is not that good, they found it difficult to manage their risk in the futures market. Now, as the quality of the market increases both in terms of liquidity and depth of the market, we have seen more participation by real economy firms.

We have been deliberately creating an environment for financial investors, institutional investors, to come into the market. So for example, in China, we have a growing group of private equity firms and some of these firms are in the securities investment area. And they're not just investing pre-IPO. So in your terms, we will call them hedge funds. But we are not calling them hedge funds in China. They're firms that make investment into traded securities, but the capital is privately sourced.

That's increasing quite rapidly in China and is already very big. And we've seen an influx of these private equity firms into the futures market. We are pleased to see that because they have good research and good investors. They have good managers. And they have played an important role in raising the quality of the futures market.

And then, of course, we are opening up the futures market. Seven contracts are now opened up to international investors. So for example, in crude oil and in iron ore and what we call low-sulfur fuel for ocean shipping. In these contracts we've seen quite active participation by international investors in our markets. Nowadays, on a daily basis, international investors comprise about 10% of the trading volume, as well as 10% of the holding of open contracts. And these international investors are mostly institutional investors and they have helped enhance our quality as well.

So you're exactly right. The next step for the Chinese futures market is to rapidly increase the proportion of institutional investors in our market, and in particular the real economy traders. You know, firms in copper, in manufacturing, in oil and mining and all these areas. If we can achieve that, we will see the Chinese futures market grow to a higher stage of development.


WL: And all those products are commodities that are important to China, and that the demand is coming from China on a lot of those products. So is that an element of the strategy, to have global benchmarks within the borders of China, showing the maturing of that marketplace?

FX: Well, in terms of commodities, it is indisputable that China has the largest market for consumption if not for production. So because of that, the participation by domestic investors in the commodities market has always been quite strong. And when we open up the markets to international investors, we expect international investors to have a strong interest to come in and then participate because there's money to be made in China, frankly. And so as more international investors come in, it helps enhance the quality of the market.

And then the price discovery is a lot more thorough and a lot more comprehensive. You talk about market indexes, and if a lot of indexes are formed in China, we are happy to see that. But I would view that as a sort of natural consequences of the increase of the market quality. It's not particularly a goal that we want to pursue, but it's kind of a natural result.


WL: One of the efforts that you recently announced in the last few months is to the Qualified Foreign Institutional Investors (QFII) and the RMB Qualified Foreign Institutional Investors (RQFII) rules. Tell us a bit about them in layman's terms, and what you're hoping to achieve.

FX: There are largely two thrusts of this reform. One is to expand the investment scope of QFII and RQFII significantly. So for example, previously QFIIs and RQFIIs are not allowed to invest into the commodity futures market in China, which is kind of odd.  Now we allow them to do so.

And the second thrust is to make the move of capital funds in and out of China a lot easier. One distinctive feature of the Chinese economy is that we still have a quite effective capital account control. And as a result, funds moving in and out is quite difficult. So the reform in this case has enabled funds to move in and out much quicker.

There's a reason for these reforms because opening up obviously is a decided strategy, so to speak, of the Chinese economy. President Xi in the last few days has spoken repeatedly in the APEC meeting and the G20 meeting, as well as in a commemorative meeting in Shanghai on the occasion of the 30th anniversary of the opening up of the Pudong New Area. He spoke forcefully for opening up more. And in the capital markets right now in China, there are two major ways of opening up to the outside world. One is through QFII and RQFII, and the other is through what we call "the Connect," the Hong Kong-Shanghai Stock Connect and the Hong Kong-Shenzhen Stock Connect.

The connect is distinctive because it enables funds to move in and out of China on an instantaneous basis. So we've seen a lot of firms choose that connect channel to invest into China. Now we like that, we welcome that, but we don't want the QFII and the RQFII channel to be completely displaced by the connect channel because QFII and RQFII channel enables funds to be physically located inside China.

And I would say it's a whole lot easier to more thoroughly regulate the QFIIs and RQFIIs to make sure that their investment conduct inside China is appropriate. And that is good, right? It's not putting unnecessary burdens on international investors. That is good because we need to know what these international investors are doing inside China.

So we want to strike a balance between the connect program as well as the QFII program and make these two channels equally effective in terms of attracting international funds into China.


WL: So you don't have a preference of the QFII or RQFII program versus the connect program as China's markets mature. But do you see a shifting from one to the other as China's markets mature?

FX: Well, I don't have real preference on that. I think it kind of depends on the mixture of these two channels. It depends on how the domestic regulation develops and how our capital account controls are being reformed. And then on how the regulatory cooperation is between Hong Kong and the Chinese mainland and in the future, perhaps between another jurisdiction in the rest of the world and China. If we have smooth, good cooperation in terms of regulation, then we will feel a lot easier about investors investing in China from a faraway place.

So all these things are developing, but I think we don't have a preference for this or that. It really depends on which way can better develop the Chinese market.


WL: China obviously has market regulators like the CSRC, it has banking regulators like the China Banking and Insurance Regulatory Commission and it's got the People’s Bank of China, and all these authorities regulate various parts of the market. In the United States, we have a coordinating body called the Financial Stability Oversight Council that allows the regulatory authorities to talk and make sure that they're coordinated and harmonized on issues. Can you tell me how the Chinese authorities communicate and coordinate with each other, especially on cross-jurisdictional issues like close-out netting?

FX: I think every country needs that coordination. We know that very well after 2008, and China in that aspect actually is in a better position than most other countries. We have a very effective central government and all regulations over the financial markets are already unified in the sense that every market has only one regulator, unlike in the US for example.

We have primarily three regulators. The central bank, which is called the People's Bank of China, regulates payments and regulates certain over-the-counter securities derivatives. It also regulates some part of the bond market, the institutional or interbank bond market. And then the capital market is largely under the CSRC. And then the banking and insurance regulation is under the CBIRC.

And invariably, these three regulators have to work together in certain areas like close-out netting and these things. In our system, we have what we call a finance committee under the state council, and that committee is chaired by a vice premier. So he convenes that committee meeting quite often. I don't know how often the FSOC is convened in the United States but here in China, it's almost weekly and if not weekly at least biweekly. So every two weeks that committee convenes a meeting with all the heads of the three regulators as well as a representative from the Finance Ministry and a representative from the National Development and Reform Commission, which is kind of a coordinating body for the overall economic policy making. They all meet together and they discuss whatever issues that have emerged in the capital markets as well as in the broader financial market.

So our form of government is quite centralized, and central government is very effective, too. So in terms of coordination, we don't have a major issue. If there's any issue, it would be that our vice premier is extremely busy because he's in charge of so many things. So sometimes it's quite difficult to put our own agenda onto that committee's meeting. But once it's there, the coordination is quite smooth.


WL: One question I wanted to ask you is more of a topical question that came up last week at our CSRC international advisory council meeting. A lot of the people on that council were talking about sustainability and ESG products that are listed around the world and it's a growing trend. I'm just curious if this is a trend that's starting to show itself in China as well, and are you seeing any products listed on the securities markets or the futures markets?

FX: You know, there are two issues. One is on the issuer side. You want issuers to issue what we call "clean" products. So in China, clean bonds have been issued on a quite large scale. And then on the investor side, we want to encourage investors to buy "clean" securities.

Right now in China, the issuer side is a little bit stronger. We have required mandatory disclosure of ESG information, particularly the environmental information by listed companies in what we call the environmentally sensitive industries. We are now in the process of strengthening that requirement and maybe someday not in the distant future all of the listed companies will have to disclose information in the environmental area. Then we can achieve what President XI just said over the last few weeks, that China is going to achieve a carbon neutrality by 2060 and that we will achieve what we call the carbon peak by 2030, I would expect the capital market to play a much more important role in climate change.

Now, specifically in our futures market, we have been researching and devising carbon futures for some time. The carbon market in China is already quite big. And right now, the market is limited to the cash trading market. But we are quite determined to launch a carbon futures market to price carbon, so that firms can better plan their carbon reduction program. So we expect that the capital market to play a critical role and in my view an irreplaceable role in the response to climate change.


WL:  The priorities and the advancements that you've made over the last several years have been enormous. But what is it that you're looking forward to in our markets coming out of China in the future?

FX: The Chinese futures market is quite big, but we are still, I believe, quite at the initial stages of development. The quality of the market still has to be enhanced significantly to serve our real economy much better.

The US futures market is a market that China has looked to for experience. And we continue to view the US futures market as an example that we should learn from. We may not adopt every practice in the US market, but obviously your market has a much longer history and is a much deeper market. We look forward to having more exchanges of information between the Chinese market and the American market.

And then secondly, we welcome US investors to trade in our market. The Chinese market offers a significant opportunity for traders, for investors, and it is also a market with a lot of potential for the futures firms around the world including American firms. Our futures market right now is fully open to international participation. JP Morgan, for example, has just been granted a license to have 100% ownership and operate in the licensed futures brokerage area. We welcome more US futures firms to come and set up shops inside China and grow their business and help develop our futures market.

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