The evolution of commodity markets in China


Trading volumes on China’s derivatives exchanges have followed an upward trajectory as investors familiarize themselves with futures and options

The increased uncertainty caused by the COVID-19 pandemic is pushing risk management to the top of business priorities, increasing domestic demand for existing and new derivatives. At the same time, the increasing levels of foreign investment in China have also created an increased need to use futures and options, further stimulating the development of the derivatives market.

The growth of derivatives

Derivatives are still a relatively new product in China compared to Western markets. The first futures exchange was approved in China in 1990, and since then the number of different products available has gradually increased, with new products continuing to be launched.

Today, China has five national derivatives exchanges offering futures and options on agriculture, energy, metals, chemicals, stocks and bonds. Trading volumes have followed an upward trajectory in recent years as domestic investors become more familiar with futures and options and demand from foreign investors increases.

More risk management needs

Derivatives play an important role in helping individuals and businesses manage risk and protect against future adverse movements in the price of a commodity or financial product by allowing them to set a predefined price at a price point. future date indicated.

The impact of COVID-19 has resulted in significant volatility in asset and currency prices, increasing the need for risk management programs.

At the same time, futures and options also help to increase the liquidity and efficiency of financial markets, as they can be more profitable than the outright purchase of an asset, resulting in higher trading volumes. high and lower transaction costs.

Rising domestic demand

The use of derivatives in China may increase in the long run as the product itself and the role it plays in risk management are better understood. This trend could be accelerated by the volatility of global commodity and energy prices, as it could increase the adoption of risk mitigation tools by companies.

Domestic demand for derivatives is also likely to be boosted by regulatory changes. As of April 2020, the China Securities Regulatory Commission (CSRC) has authorized the five largest Chinese state-owned commercial banks and a number of insurers to trade domestic bond futures under a program. pilot which could lead to the opening of the market to a large number of institutional investors.

Growing foreign demand

Demand for futures and options from foreign investors is also increasing as China continues to open up its financial markets. Foreign investors can invest in the A-share market through the Qualified Foreign Institutional Investor (QFII) and Renminbi Qualified Foreign Institutional Investor (RQFII) programs, as well as through Shanghai-Hong Kong, Shenzhen-Hong Kong and Shanghai-London shares connect programs.

The CSRC expanded the QFII to include futures, commodity futures and options for the first time in January 2019. This move was followed in April 2019 by the China Financial Futures Exchange, relaxing the rules for trading in index futures, including reducing margin requirements and fees, and allowing more trading activity, to help meet the needs of foreign investors.

Some market watchers believe that a shortage of risk management tools has held back China’s inclusion in global indices. For example, FTSE Russell decided not to include China in its FTSE World Government Bond index in 2019 due to limited access to derivatives. As China continues to open up its financial markets to foreign investors, its derivatives market must also grow to meet the diversification and hedging needs of these investors.

Looking forward to

China has already started to reopen following lockdown measures to limit the spread of COVID-19, and its economy is showing strong signs of rebounding. As economic activity continues to normalize, futures and options may play a role as investors and businesses seek to hedge against global price volatility.

At the same time, the People’s Bank of China stressed that the COVID-19 pandemic would not impact policies aimed at continuing to open up the country’s financial markets. In fact, in January 2020, the foreign ownership caps on futures companies were lifted, followed by the end of the caps on foreign brokerage houses and mutual fund managers in April, a year ahead of schedule. . In May, the investment quotas on the QFII and RQFII were also removed.

All of these factors are expected to drive the expansion and development of Chinese derivatives markets.

This expert analysis was published on Open Markets, the official thought leadership magazine of CME Group.

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