CHINA'S decision to suspend trading in Treasury-bond futures is understandable but regrettable. The China Securities Regulatory Commission took the decision in the wake of two scandals involving a total of eight broking houses. The authorities felt they lacked the power and sophistication to regulate traders adequately.
Such caution appears admirable. If a single futures trader in tightly regulated Singapore could apparently send tremors around the financial world, the potential for disaster in a loosely regulated Chinese exchange is high. However, Beijing is being too heavy handed in abandoning its 18-month experiment in Treasury-bond futures at the first sign of serious trouble.
Futures are high-risk financial instruments that often attract speculative funds. In China's case, softness in the equities market combined with a crackdown on property speculation has sent spare cash flooding into futures. The regulatory commission sought to limit speculation by raising margins and setting limits on Treasury-bond futures. It was the failure of this attempt to limit speculation that indirectly led to the indefinite suspension of trading.
However, futures serve a more important purpose than offering an opportunity for speculation. They allow investors to hedge against possible losses in a volatile economy in which commodities trading is an important factor. They allow for effective risk-management. There is nothing wrong with futures as such but trading must be closely monitored and regulated. It was the absence of a national futures law in China that provided a climate for excessive speculation and the absence of adequate monitoring that facilitated rogue trading.
Beijing should, as a matter of urgency, promulgate a national law to regulate the country's futures exchanges. At the same time, the regulatory authorities must acquire the technology to monitor trading in a timely and effective manner. Further, futures laws must be rigorously enforced and transgressors punished, without regard to their business or familial connections.
For the authorities to abandon an experiment when it goes conspicuously wrong is a throwback to the days of socialist planning. Futures, however, are not instruments to be played with then abandoned when they strike a discordant note. It is the players who are to blame, not the instruments. Futures can play a useful role in China's development and Beijing would be wrong to abandon them altogether. China should regard recent problems as teething troubles to be expected in developing increasingly sophisticated financial markets. The absence of effective supervision of futures markets reflects wider problems of control, application and enforcement and Beijing should address these issues. Investor confidence is a fragile thing and a stop-start approach is more likely to encourage speculation than to create a foundation for sustained development.