How tight is China's grip on its commodity futures market?
Wednesday, 22 February 2012 | 00:00
Chinese authorities keep a tight grip on the country's commodity exchanges as part of efforts to deter speculators from driving up food and resource prices.
The three commodity futures exchanges, in Shanghai, Dalian and Zhengzhou have only a small window to foreign participation. Financial institutions are barred from participating, and brokers cannot take positions.
There is so far no over-the-counter derivatives market based on Shanghai Futures Exchange contracts, as exists for the London Metal Exchange and CME, although one is expected to develop over the next five years.
Western banks, trading houses and producers are keen to grow their footprint as urbanization in the world's top commodities consumer boosts demand for goods, and as Beijing slowly relaxes its tight grasp on currency and commodities trade.
Here are some questions and answers on the issue:
ARE FOREIGN BANKS PERMITTED TO TRADE COMMODITY FUTURES DIRECTLY?
As China still has a segregated regulatory framework for its financial industry, the securities, banking and futures operations are separated by strict firewalls.
That means financial institutions such as banks, securities firms, mutual funds and insurance companies are banned from becoming members of futures bourses or clients of futures firms.
The only exception granted so far is the gold market, where 21 local and seven foreign ones are now trading members on the Shanghai Gold Exchange. For the Shanghai Futures Exchange, only four domestic commercial banks and two foreign banks are allowed to trade its gold contract.
CAN FOREIGN BANKS ACCESS THESE MARKETS INDIRECTLY?
Yes, but only by setting up a locally registered non-financial unit, through which they can then trade via brokers.
Wall Street bank Morgan Stanley, which runs a Shanghai office, has a wholly owned foreign enterprise (WFOE) under a non-financial umbrella to trade metals and agricultural products. Other foreign banks with trading WFOEs include South Africa's Standard Bank, JPMorgan Chase & Co, Deutsche Bank, and Citigroup Inc, which are already active in the metals space.
WHAT ABOUT PHYSICAL TRADING HOUSES?
Non Chinese trading companies must also register a local, non-financial trading WFOE before they can apply for membership at the three futures exchanges to trade for themselves as long as they also meet other criteria, such as capital size and sound trading records.
Some international trading firms, such as Louis Dreyfus and BP Plc, are futures bourse members through their trading WFOEs; Louis Dreyfus joined the Dalian and Zhengzhou exchanges in 2006, and in May 2007 BP joined the Shanghai futures exchange, which runs China's only oil futures contract, fuel oil.
Agricultural giants such as Wilmar, Cargill CARG.UL, Bunge, Louis Dreyfus and Toepfer International are very active on the Dalian exchange. Commodity trading houses Trafigura TRAF.UL and Noble Group also have trading WFOES.
As for brokers, U.S.-based INTL FCStone has two WFOES, opening one in November registered in the free trade zone of Yangshan Port, while French brokerage Newedge tied up with Chinese financial conglomerate Citic Financial CITIC.UL to open a WFOE under Citic Newedge Futures.
Among metals producers, Polish copper miner KGHM KGHM.WA has one, while the Chinese unit of top copper producer, Chile's Codelco CODEL.UL, has opened a WOFE in the past 1-2 months.
However, red tape prompts many global trading firms to open trading accounts at futures brokerages instead of applying for bourse membership.
Brokerage clients have to pay brokerage service fees and sometimes are subject to smaller holding ceilings than members.
WHAT'S THE TIMELINE FOR OPENING UP THIS MARKET FURTHER?
China is under no pressure to open its futures markets. And unlike its securities, banking and insurance sectors, Beijing has made no specific commitment to open its commodities futures market, except for gold.
The global financial crisis, besides numerous scandals in which Chinese firms suffered huge losses trading derivatives overseas, will make Chinese regulators more cautious than ever.
However, ambitious plans by the city of Shanghai to become an international financial centre have buoyed hopes that authorities may ease curbs and allow more foreign participation.
The Shanghai Futures Exchange has said it is looking at ways to allow banks, trusts, securities and fund companies to enter the commodities market.