China wants say in 'price discovery' in everything


Time to Focus on Chinese Derivatives

By William Barkshire
Financial Times, London
Tuesday, October 7, 2014

There have been many false dawns in the progress to open up China's participation in global capital markets.

That has led to the loss of interest by some overseas investors and in some cases retrenchment. However, under Xi Jinping's leadership market liberalisation is now gathering a real pace and international players should start paying more attention to concrete evidence of development.

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The announcement in April by the central government of the Hong Kong Exchanges and Clearing and Shanghai Stock Exchange Stock Connect link underpins this tangible change.

Set to go live later this month, it is likely to see interest from funds that do not currently have access to China via the qualified foreign institutional investor quota schemes seeking either yield pick-up or to trade the valuation differential between stocks listed in both Hong Kong and Shanghai.

While this project is significant, it will be eclipsed in the long term by the scale and scope of other projects. The key policy focus in Beijing is on developing those markets that can assist China in its economic development, or what might be termed its "real" economy rather than just the financial services sector.

Central to this is the move toward market-based pricing in commodities, where China is the major global consumer. Here the political desire is for price discovery to take place in Asia and not just in London, New York, and Chicago.

State-owned enterprises are poised to be allowed to increase their hedging practices in a wide range of commodity futures and options markets. As a result they are actively seeking to increase the sophistication of their risk management practices both domestically and in international markets.

The launch in the past two months of over-the-counter commodities clearing in iron ore and coal by Shanghai Clearing House and the international board of Shanghai Gold Exchange -- a spot and forward market -- are significant developments and should be more closely watched.

The Shanghai Gold Exchange is particularly relevant, as while heavily controlled, it offers fully fungible access to onshore liquidity in precious metals for international companies. It will also offer access to a highly interesting arbitrage between global and domestic demand-driven prices.

By the end of this year, OTC commodities trading and clearing will be extended to other products, including copper in both spot and forward markets in the Shanghai free-trade zone. It is interesting to note that both the Shanghai Clearing House and Shanghai Gold Exchange are regulated by the People's Bank of China, which seems to be at the forefront of implementing these important market reforms.

There are also expectations that we will finally see the launch of the Shanghai Energy Exchange in the Shanghai free-trade zone by the end of the year -- a very significant market development as it will allow remote market access from equivalent regimes recognised by the China Securities Regulatory Commission.

The launch of exchange-traded options on the highly-liquid CSI futures contract operated by the China Financial Futures Exchange will come next year. Initially it will be a restricted market, but in due course it could set a new global benchmark in options liquidity.

Many industry veterans have become wary of investing in market development initiatives in China -- the guiding principle for many Western firms has also traditionally been to put your costs into China but not your revenue line.

Economic development, including the introduction of efficient market-based structures, is core to maintaining the primacy of the Chinese Communist Party. Recent events in Hong Kong mask that economic prosperity remains central to political stability well ahead of any calls for democratic reform. China is also increasingly aware of its increased interdependency with the rest of the world and a need for more balanced commercial relationships that are mutually beneficial.

In short, those market infrastructure providers specialising in trading, clearing, and collateral management need to focus on these real market developments now as the time between the final announcement of the launch date and going live is notoriously short in China. This pace is going to quicken.

For those that begin planning now and building key relationships, the opportunities in derivatives will be a once-in-a-lifetime development.


William Barkshire is managing director of Agora Partners, based in Hong Kong and Shanghai.

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