Will hogs and apples spur China’s real economy or are they just speculative bets?

China is keen to use the futures market to help businesses hedge against risks. A record 4.13 billion futures contracts were traded in 2016, up 15.6 per cent from 2015

PUBLISHED : Tuesday, 30 May, 2017, 4:54pm
UPDATED : Tuesday, 30 May, 2017, 10:31pm

China’s securities regulator has set its eyes on pulp, hogs, red dates and apples, betting that future contracts of these commodities will help spur the real economy.

Fang Xinghai, a vice-chairman of the China Securities Regulatory Commission (CSRC), told a forum hosted by the Shanghai Futures Exchange last week that futures trading could help find reasonable and market-based prices of industrial and agricultural products, in turn reinforcing the mainland’s supply-side reform.

“Futures contracts and options are becoming a necessary risk-managing tool for companies,” he said. “They have played an important role in boosting the agricultural development and supply-side reform.”

If his remarks are anything to go by, the regulator is adamant in keeping its pace with the mainland leadership amid the drawn-out economic reforms, pledging to not let complacency creep in ahead of the significant Communist Party Congress in the autumn.

On the face of it, the CSRC’s plan to introduce more commodity futures contracts to the exchanges appears to be well-founded.

Take red dates, known for its nutritional value in China. Its market size was valued at more than 50 billion yuan (US$7.25 billion) in 2015.

As growers, processers and retailers have access to futures trading, they will be able to hedge against price volatility in the food so as to better manage their business.

The CSRC has been harping on the benefits of liberalising the futures market over the past decade, describing it as a much-needed hedging tool for businesses in the world’s second-largest economy.

According to the China Futures Association, a record 4.13 billion futures contracts were traded in 2016, up 15.6 per cent from a year earlier.

Nonetheless, the robust increase of trading volume does not necessarily depict a rosy picture of the country’s futures market.

On the mainland, commodity futures contracts are traded in three bourses in Shanghai, Dalian and Zhengzhou.

Financial derivatives including stock-index futures and government bond futures are traded at Shanghai-based China Financial Futures Exchange.

A combined 54 futures products including steel, rubber and copper contracts are listed in the exchanges.

Relaunch of bond futures trading in sight

“Futures trading has already been melted into the operating system of the country’s non-ferrous metal industry,” said Shang Fushan, a vice president of Chinese Nonferrous Metals Industry Association. “Using the trading for hedging purpose is an effective way for them to improve corporate performance.”

But the road to a mature and established futures market in China appears convoluted.

The heavy speculative sentiments that predominate the Chinese markets have long worked against the country’s futures market. Thousands of small traders dart in and out of the futures contracts hoping to get rich overnight.

Using the trading for hedging purpose is an effective way for them to improve corporate performance
Shang Fushan, Chinese Nonferrous Metals Industry Association

Despite the strong turnover, positions held by futures traders represented only 1 per cent of China’s gross domestic product in 2016, compared to 70 per cent in the United States, according to Fang.

The majority of investors either buy or short sell on the futures market, closed out their positions before the delivery dates.

They either closed a long position by selling it, or closing a short position that involves buying it back.

The gap between the price at which the position is opened and the price at which it is closed represents the gross profit or loss.

Wild price swings in commodity futures contracts often called regulators into action, who raised the minimum margin requirements, or the minimum deposits for trading the futures contracts, to curb over speculations.

More importantly, the majority of the large-scale businesses in China have yet to learn how to make use of futures trading to hedge against risks.

Fang said that only 20,000 out of the mainland’s 500,000 companies whose annual sales exceed 20 million yuan have participated in futures trading.

The CSRC is considering giving foreign investors a widened access to the mainland’s futures market, including an imminent launch of the country’s first crude oil futures with trading opened to global players.

Beijing vows to open commodity futures trade to foreign investors

It is an apparent effort aimed at setting a healthy tone for the volatile market.

In 2011, the CSRC also studied to set up a qualified investor mechanism to expel small and unseasoned investors from the futures bourses.

But the policy failed to come to pass.

“Betting on futures with a small amount of cash is enjoyable,” said Ben Zhou, a Shanghai-based individual commodity futures investor. “As long as high volatility remains, I’ll continue to play futures.”