Growth in China. In association with: An inside view of the world s most exciting market. Held on September 18, 2012 in Singapore ROUNDTABLE

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1 THE GLOBAL DERIVATIVES MAGAZINE ROUNDTABLE Growth in China An inside view of the world s most exciting market Held on September 18, 2012 in Singapore In association with:

2 2 OCTOBER/NOVEMBER 2012 Sponsored by: Chinese derivatives: building on a decade of growth China is the ultimate growth market for global derivatives. And as the country seeks to grow the range of products on offer and build regional benchmarks, the markets are tipped to open up for foreign investment and for outbound investment on international markets. On 18 September, as part of the Asia Roundtables held in Singapore, William Mitting discussed the development of the market with a group of market leaders. Speakers Chairman: Yao Guang, chief executive, Galaxy Futures Moderator: William Mitting, editor and publisher, FOW Group Ramir Cimafranca, head of institutional sales, Asia-Pacific, Newedge Association Lionel Sancenot, executive vice president, Trading & Connectivity, SunGard Ma Wensheng, chairman, Xinhu Futures and vice president, China Futures Association Chen Xiaoyi, marketing and sales director, Nanhua Futures (Hong Kong) William Mitting, FOW: China is without a doubt the most exciting derivatives market in the world. Over the last decade, volumes grew from less than 5m contracts in 2001 to over 1.6bn in Now, as the market begins to open up both for international access and for outbound trading on international exchanges, all eyes are on China. Before, we come onto the recent growth, I would like to begin with our chairman today, Mr Yao Guang, the chief executive of Galaxy Futures, who will provide an outline of the key drivers behind the recent growth. Yao Guang, Galaxy Futures: Thank you William and welcome to all of our panellists today. Since 2000 trading volumes on the Chinese markets have grown to over 1.6bn. Our study of the situation found that the rapid growth is down to four key reasons. The first reason is the growth of the Chinese economy. Over the past 13 years the GDP growth of China has tended to be in excess of 10% and its proportion of the total global economy continues to grow. Between 2000 and 2010, steel and car production went up by more than 300% and other sectors also saw considerable growth. During the strong economic growth in China, the futures markets have provided risk allocation, resource allocation and price discovery. The second reason is that as Chinese enterprises have got stronger they have faced increased international volatility in the price of raw materials. Over the past 10 years, the volatility of commodity prices has increased considerably. Market participants have learned that they need to hedge against such volatility. Galaxy is a joint venture with RBS and we have around 1,600 institutional clients that need to hedge their risk. Over the past two to five years a lot of listed companies in China have entered the market to hedge their exposure to the price of raw materials. The third reason is that the Chinese government

3 OCTOBER/NOVEMBER and the China Securities Regulatory Commission have recognised the importance of the futures market and its benefits to the real economy. In the 1990s derivatives markets in China were very volatile and the government and the CSRC thought that the futures markets actually aggravated risk and volatility. After 2000, there were a lot of changes. The government and the CSRC recognised the importance of the markets. As the Chinese markets become global, these authorities are changing their policies. As a Chinese FCM we are closely monitoring the government and its positions on the derivatives markets. Over the past 10 years more and more has been said on this area. For example, [Chinese Premier] Wen Jiabao earlier this year talked about how important the futures markets are going to be. For the Premier to say this suggests an opening up of the markets. The fourth reason is that there has been a lot of innovation in the market and a lot of education. Many Chinese investors, the regulators and other parties have learned a lot more about derivatives products. I believe that the benefits of the markets opening up and the successes of the various joint ventures we have pursued will persuade the CSRC to open up more of the market. We believe there will be more attractive opportunities in the derivatives markets over the next few years. There are a number of new upcoming launches including crude oil futures, treasury bond futures and options based contracts, which we will talk about later on. So, over the last decade, the futures market has grown by more than 100 times and now we must now work together to develop the market to the next level. Mitting: Thank you, and Mr Ma, as Chairman of a large FCM and vice president of the China Futures Association, you have a good view of the markets. What trends are you seeing out there? Ma Wensheng, Xinhu Futures: There is great attention being paid to the Chinese derivatives markets from across the world at the moment. The fast growth in Chinese futures markets is due to a series of sound laws and regulations. In 2007, the CSRC issued laws and regulations that ensure the Chinese markets have safe and secure operating systems. This sound system guarantees the stable development of the Chinese futures market. Since 2008, the Chinese futures market has been oriented towards servicing the national economy and real economy. Since then, the innovation in the market has always been focused towards this end and several newly listed commodity futures are centred on this goal. In order to understand the Chinese market, you have to see it from the macro view. The first stage of development was during the 1990s, which was an exploratory stage in which we were understanding the markets and how they worked. In 2007, when the financial crisis hit, there were a lot of fluctuations in commodity prices and global markets and that was when Chinese market participants became serious about hedging their risks. This is why in 2010 the market had grown by more than 100 times in a decade. From this year, there will be more opportunities because the CSRC is loosening up the requirements for private investors and a lot more products are coming to the market. Mitting: Indeed, there has been a lot of talk about the CSRC recently taking steps to open the market. It is a key issue for many market participants. Mr Yao what changes have you seen recently? Yao: The CSRC has always insisted on implementing an active open-door policy, and the level of internationalisation of Chinese futures markets is increasingly. Through domestic companies, overseas investment in the Chinese futures markets is taking shape. Initial data shows that the domestic futures companies have nearly 2,000 overseas clients. Under the CEPA framework, there are three Hong Kong institutions that have stakes in mainland futures companies, and it is now allowed for European and American financial institutions to acquire up to 49% of futures companies in China to operate a joint venture. Currently the basic ideas and overall plan to open up the futures market to the outside world is positively discussed. In addition, the Chinese government has promised to expand the limit of 49% for overseas institutions taking stakes in futures companies and to allow QFII investment in stock index futures. Also, the CSRS is currently preparing for the introduction of qualified foreign futures investors. At this stage, the CSRC is concentrating on intensifying efforts on Bring In, fully absorbing the experience of mature markets, and promoting the development of Chinese futures markets. For example, the CSRC is in close coordination with the Central Bank, the Ministry of Finance, Ministry of Commerce and other ministries to speed up the preparations for crude oil futures. This innovation has made substantial progress. The benchmark oil, offshore transactions, delivery in the bonded area and other rules have been established. Meanwhile, the CSRC regards launching crude oil futures as an opportunity to promote reform and the opening up of the futures markets, and to introduce qualified foreign futures investors. Yao: rapid growth There is great attention being paid to the Chinese derivatives markets from across the world at the moment Ma Wensheng

4 4 OCTOBER/NOVEMBER 2012 Sancenot: more investment We see growth in local traders arbitraging local contracts against international markets such as the London Metal Exchange Lionel Sancenot Mitting: Looking at the domestic market, who is trading what internally within China at the moment? Ma: Currently there are total 28 listed futures products on the Chinese markets, representing around 8 trillion RMB production capacity. Considering that the volatility of commodity prices is around 40% every year, there should be 3.2 trillion RMB or equivalent that needs to be hedged. For this reason, more and more enterprises have entered this market which drives the futures market s development. In recent years, due to development of private funds, more and more fund companies have been designing products that are related to futures and investors are becoming much more professional. Mitting: That must have an impact on the technology being used as well. What trends are you seeing there? Is the increased professionalism being mirrored in investment in technology? Ma: Over the last few years the technology improvement in the futures market has been enormous. A good company has reduced its trading time to microseconds. This is why Chinese companies have to work with international IT providers to develop in this area. The sophistication of the market is also growing with more interest in options and arbitrage and this too is leading to investment in technology. There is also a change in the composition of Chinese investors. The thing about the Chinese markets is that the enterprises that are trading are becoming bigger and bigger. The other thing is the development of institutional investors in the futures markets. What we need to do is to adopt a lot of the overseas strategies, models and products that exist now. A lot of Wall Street investors are coming to China and working with Chinese institutions to develop these methods. So we hope that everybody will keep a close eye on the Chinese markets. Mitting: We have heard about the growth of investment in technology in China, but where do you see the main areas of demand from SunGard s perspective Lionel? Lionel Sancenot, SunGard: If you look at the evolution of the Chinese markets, you can see that it was previously a self-centric market but that has really changed over the past few years and we are now seeing new investments in a variety of areas We are seeing Chinese players setting up in Hong Kong to trade, for example, and using Hong Kong as a base to trade overseas markets. This has taken a few years but it is a growing trend that is becoming more prominent. With that comes a lot of investment in both front and back office and clearing systems. The other area of growth that we see is local traders in China arbitraging local contracts against international markets such as the London Metal Exchange for example. So for those we need to develop specific applications in Chinese that can connect to both local and international markets. Then there are the international firms that are trading under the QFII programme for whom we have developed an order management programme and connectivity to Chinese exchanges and have partnered with a big Chinese brokerage firm to accommodate this international order flow. SunGard has been in China for a long time and the historical business was to provide local connectivity to local FCMs but with the growth of new areas such as option trading on international markets, we have expanded our operations. So for us, we are happy to have invested heavily in the Chinese markets. We made a big bet in 2005 on the Chinese markets and this investment is now paying off and we see a lot of opportunities in the next two to five years in China. We expect a lot of investment in front to back office technology. We have also developed high speed connectivity and expect to see growth in algo trading. Not surprisingly China is catching up with international markets at a fast pace and we are delighted with the progress so far. Ma: About 40% of profit within futures companies in China is used for technology investment every year. In our company, it takes 1 to 2 milliseconds for an order in-and-out of futures exchange. Many trading tools such as overseas quantitative and program trading and financial engineering are now being applied to the Chinese market. The scale of the application of these tools has been growing in recent years. Trading behaviours are more complex and diversified. Trend trading, hedge trading, arbitrage trading, long term, mid-term and short term trading are all there in Chinese market today. Mitting: There is a wave of optimism at the moment about China and it is great to see that is shared by the local participants and other people that are working closely with the market. One particular launch that is generating a lot of interest is the upcoming crude oil futures contract that is due to be launched by the Shanghai Futures Exchange. What is the background to that? Yao: In May, the CSRC chairman Guo Shuqing said that during 2012 China will open a crude oil futures market, which will be the third global crude oil futures market after those of United States and United Kingdom. The launch of the crude oil futures will be an international landmark for China s futures

5 OCTOBER/NOVEMBER market, and it provides a great opportunity for foreign investors to participate in China s futures market. In 2011, China consumed 454m tonnes of crude oil, second in the world, accounting for 10.7% of world consumption. China imported 250m tonnes of crude oil in 2011 and its imports accounted for 55.11% of domestic consumption. Since 2008, China s crude oil consumption has risen by an average of 27m tonnes annually. I am the director of the SHFE Energy & Commodity Committee. We at Galaxy Futures have worked hard with the SHFE on the crude oil launch and at the moment, the crude oil project is being drafted and revised by SHFE, the National Development and Reform Commission and the CSRC who are reviewing the specifications and operations of the contract launch. China will use the crude oil launch as an opportunity to push forward the futures market reform and opening up of the markets. It is also good to develop a China standard and China price for commodities. The present moment is a very important turning point in terms of oil consumption in China. There will be a new benchmark offered to global investors by listing China oil futures. Currently, the Asia-Pacific time zone doesn t have a benchmark for oil. The new international oil pricing mechanism constructed in China would be a supplement for the global oil market and we hope the Singapore market will combine with China to generate an efficient Asia-Pacific alliance. Mitting: We will come onto how international traders can access China shortly but another side to that coin is Chinese traders trading out of China. Certainly if you talk to international exchanges, not surprisingly, that is one of the big opportunities for them. But currently what is the status for trading out of China and how many participants are there doing that? Ramir Cimafranca, Newedge: There are two major avenues for Chinese traders to trade overseas. One is the Qualified Domestic Institutional Investors scheme and with that goes the state owned enterprises that are allowed to trade overseas. The second major avenue is through subsidiaries of the six FCMs that are based in Hong Kong and the securities companies that have offices in Hong Kong and are able to trade futures and options. The current National Pilot Programme for outside trading will open more avenues for outbound trading. According to informal opinions that I have heard from the industry the amount of futures trading going through the FCM subsidiaries represents only around 5-10% of the total interest in China to trade overseas markets; that is what makes the National Pilot Programme so attractive. Chen Xiaoyi, Nanhua HK: The Chinese futures market started in the early 90s with an initial irrational prosperity as investors participated in mainly outbound trading. In 1993, the regulator forbade domestic investors from participating in outbound trading to further regulate the futures market. In 2006, the CSRC approved six quality futures companies to set up branches in Hong Kong. Nanhua Futures is one of the pilot companies to develop an outbound futures trading business. According to the current rules of the State Council, only domestic futures companies are allowed to conduct futures business. The futures trading administration rules issued in 2007 indicated that a futures company can apply for conducting outbound brokerage, futures investment consulting and other futures business approved by the State Council s futures supervision and management organisation. The futures investment consulting business was officially launched in 2011, while asset management was officially launched in August However, the outbound futures brokerage business has not been launched yet. Mitting: So who is currently allowed to trade externally? Chen: Currently, there are different groups participating in the outbound futures business. Domestic Chinese corporate clients who can directly participate or set up overseas companies to indirectly participate, with the regulator s approval. Then there are the mainland Chinese individual/retail investors that have already participated in Chinese futures trading. Finally, there are the mainland Chinese institutional investors who participate as private equity companies. Mitting: And where are they trading? Chen: The main instruments cover six big categories and nearly one hundred products, such as metal futures, foreign exchange futures, index futures, energy futures, agri-commodities futures, interest rate futures, covering the Chicago Mercantile Exchange Group, the London Metal Exchange, the Hong Kong Futures Exchange, the Singapore Exchange, the Tokyo Commodity Exchange, Liffe, Eurex and others. Currently, there are also some new changes concerning outbound futures exchange participation. With the rise of emerging markets, investors not only focus solely on developed markets such as Europe, US, Hong Kong and Singapore, but also have started exploring some futures markets in the emerging markets, such as India, Malaysia and Brazil etc. Ma: solid foundations The amount of futures trading going through the FCM subsidiaries represents only around 5-10% of the total interest in China Ramir Cimafranca

6 6 OCTOBER/NOVEMBER 2012 Mitting: Is the market to trade externally opening up though? Chen: bullish Through applying for the membership with overseas futures exchanges, Chinese FCMs have the opportunity to offer Chinese enterprises direct global market services Yao Guang Chen: In the future, after the CSRC opens up the outbound futures brokerage business, Chinese traders will be able to enter international derivatives market, in two ways. Firstly, Chinese futures companies can become international main-stream exchanges members directly. However, there are several considerations. Firstly, to what extent does the Chinese regulator recognise the international exchanges? For example, In Hong Kong, the exchange needs to file for record at Hong Kong Securities Regulatory Commission. Chinese futures companies can also look for a major international financial institution to work as its agent to carry out outbound futures business. This way is easier, which may be the main choice for Chinese futures companies participating in outbound futures business at the initial stage. As one of the first batch of Chinese FCMs setting up branches in Hong Kong and carrying out outbound futures business, Nanhua Hong Kong is bullish about the development of outbound futures business in China. We expect that there will be problems facing outbound trading in China though. These problems are getting attention and are in the process of being studied and resolved. Currently, the CSRC is actively promoting system innovation and business innovation, and is also studying the launch of the outbound futures brokerage business. We believe that Chinese futures companies should be able to apply for outbound futures brokerage licences in the foreseeable future. This is the inevitable trend. In order for outbound futures trading business to flourish in China though, China s other financial systems and allocation service system need to be improved and issues of RMB control and bonded-delivery etc. need to be resolved too. At the same time, the illegal overseas futures trading still exists in the Chinese market, especially for gold and precious metal trading. There are no risk management systems in place and no regulator s restrictions, hence investors benefits are hardly protected. Mitting: Obviously this is a great opportunity for international exchanges but it is also a good opportunity for Chinese traders. What do you see as the key benefits? Yao: Firstly, the membership with global derivatives exchanges is beneficial to meet the hedging demand for Chinese investors, and to provide services for Chinese enterprises trading in the international market. Secondly, it can enhance the international standard of Chinese FCMs, especially in regard to risk management and customer service. Thirdly, as China is opening its market, an increasing number of Chinese enterprises will enter the international market. Through applying for the membership with overseas futures exchanges, Chinese FCMs have the opportunity to offer Chinese enterprises direct global market services. For instance, stock index and interest rate derivatives trading are the major businesses at NYSE Liffe, and the Euribor index and FTSE100 index futures contracts are paid great attention to by Chinese investors. Meanwhile, the possible opportunity to become a member of NYSE Liffe can facilitate a direct connectivity with the exchange, which can improve efficiency and greatly save transaction costs. Mitting: So we have heard a lot about how the Chinese markets are opening up for outbound investment but is the same true going the other way. And how can international investors access China s markets? Sancenot: From a technology point of view, the backbone for connectivity is the SunGard Global Network. From this we have a number of markets connected. We have been in China since 2005 and we have local brokers that are very supportive of the network. The other piece that we have built is onshore front to back solutions in China. If an international player wants to trade from overseas or really go and create a Chinese company and trade locally we have a solution that can support that trading. Cimafranca: Obviously you have the QFII programme for international traders coming into China. This year there has been a lot of easing in the requirements right now there are 170 QFIIs in China. We have also seen the amount that can be invested increase from $30bn to $80bn. Having said that there was supposed to be approval for QFIIs to trade on the CSI 300 index on the China Financial Futures Exchange but we haven t seen the first trade on that yet. If you are a smaller investor you can set up a wholly owned enterprise can be set up in around six months. Unfortunately there are a lot of limitations and it is a difficult process. But at the moment that is the only way that foreign investors can trade in China. Unless of course you are a retail investor but even then you need to have a legal Chinese entity to trade through. Mitting: Thank you Ramir and thank you to all of our panelists today.

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