China plans to speed up derivatives introduction

"China has the potential to be the biggest futures market in Asia within the next five years."

Steve Ng, Asia head of global futures for ABN Amro Holding NV

China to accelerate development of its futures and derivatives markets to help companies cope with currency and stock fluctuations in a more market-driven financial system, officials said.

The government is considering introducing interest-rate and stock-index futures, Cheng Siwei (程思危), vice chairman of the National People's Congress, and Shang Fulin (尚福林), the top securities regulator, said today at a conference in Shanghai co-hosted with the Chicago Mercantile Exchange. They didn't give a timetable.

China making its currency more flexible, deregulating interest rates and increasing the supply of tradable shares on stock markets, increasing the need of companies and investors for tools to hedge risks.

The government hopes that a more developed domestic derivatives market will help avoid a repeat of scandals such as China Aviation Oil (Singapore) Corp, which lost US$550 million trading options in Singapore last year.

China Aviation "is a wake-up call," Cheng said at today's conference. "It's a sign that we lack the ability to hedge risk. It's necessary for China to develop financial derivatives so that we can be competitive."

A derivative is a financial obligation whose value is derived from interest rates, the outcome of specific events, or the price of underlying assets such as debt, equities and commodities.

China allowed trading in financial futures since the mid-1990s, when the government halted trading after speculation and insider trading caused the market to crash. Authorities shut all but three exchanges and scrapped more than 50 contracts.

The introduction of currency futures in China will take "a long time" and may not happen until the yuan becomes fully convertible, Cheng said.

China July 21 ended the yuan's decade-old peg to the US dollar and started managing it against a basket of currencies.

The yuan is allowed to move 0.3 percent either side of a daily fixing rate set by the central bank. The People's Bank of China on Sept. 23 widened the daily trading band for the euro, yen and Hong Kong dollar to 3 percent, from 1.5 percent. The government hasn't given a timetable for free-floating the currency.

The start of a program this year to convert non-tradable, mostly state-owned, stockholdings into common shares that can be bought and sold on exchanges has paved the way for developments such as stock-index futures, China Securities Regulatory Commission Chairman Shang told the conference.

Non-tradable make up almost two-thirds of the value of listed companies. The country is seeking to unwind five decades of state ownership and bring its exchanges in line with global standards as it opens them wider to overseas investors.

The Chicago Mercantile Exchange plans to develop China-based futures products in partnership with domestic exchanges such as the Shanghai Stock Exchange and Shanghai Futures Exchange, Chief Executive Craig Donohue said in an interview.

The Merc is trying to position itself to lead China's evolving derivatives market, and is also working with Chinese regulators and banks to encourage use of the US$600 trillion US-listed derivatives market.

"Chinese banks and financial institutions are currently using our products such as euro-dollar products, our stock index futures contracts and ultimately, we hope, the foreign-exchange contracts," Donohue said.

China trading in overseas futures to domestic lenders such as Bank of China and Agricultural Bank of China, while 26 Chinese companies are approved to trade in overseas commodities futures markets, said Steve Ng, ABN Amro Holding NV's Asia head of global futures.

ABN Amro, the biggest Dutch bank, plans to apply to set up a futures venture with Beijing-based Galaxy Securities Co to tap growing demand in China.

"China has the potential to be the biggest futures market in Asia within the next five years," Ng said. ABN Amro's revenue from China futures operations has doubled in the past two years, he said, declining to give figures.

China allows trading in 11 types of commodity futures, including copper, cotton and soybeans. As of June, the nation had about 180 futures brokerages. US exchanges trade futures contracts on more than 130 products.

China's bank last month said it will let more than 130 domestic and foreign banks trade yuan forward contracts and swaps on behalf of clients.

Forwards agreements in which assets are bought and sold at current prices for delivery at a later specified time and date. They will allow local companies and investors to protect themselves from swings in the yuan and other currencies.

The Shanghai stock exchange is studying plans to introduce exchange-traded funds, or ETFs, based on the Asia Bond Fund, ETF warrants and stock-index futures, Geng Liang, head of the exchange, said at the conference.

The Shenzhen stock exchange is running trials of stock-index futures and is studying plans for stock options, said Zhang Yujun, the exchange's chief executive.

Use derivatives would have enabled China to earn higher returns on its foreign-exchange reserves, which stood at US$711 billion at the end of June, NPC Vice Chairman Cheng said. The government made US$40 billion on the reserves last year, mainly through bond interest and appreciation of the euro, he said.