For three years Wang Liangguang, an experienced stock investor, waited patiently for the trading of stock index futures. And now, that day has arrived—stock index futures will soon be launched on Chinese financial market. The China Securities Regulatory Commission (CSRC) may officially launch stock index futures as soon as May.

After being laid off by a state-owned machine tool plant in Beijing in 1997, Wang worked for a series of private companies. In 1999, he began focusing his time and resources on the stock market, making money along the way, if only minimal amounts.

Three years ago, Wang opened an account in a futures firm, taking part in mock trading of stock index futures with the aim of gaining experience prior to the official launch of index futures. Beijing Review covered Wang's story in June 2007.

After three years of practice, Wang is ready to try his hand at making trades and accumulating a little extra cash.

Government preparations

Investors have been appealing to the government to launch the stock index futures as early as possible, giving them another investment channel. To accelerate a smooth launch of index futures, CSRC has spent years preparing for the event.

On September 8, 2006, the China Financial Futures Exchange (CFFEX) was established in Shanghai by the Central Government to regulate stock index futures, options and other financial derivatives. On October 30, 2006, the CFFEX began mock trading in order to familiarize investors with new trading rules associated with stock index futures. Wang was among the investors who opened futures account at this time.

The Shanghai Shenzhen 300 Index was used for the mock trading of stock index futures. The index selects 300 types of A shares from the Shanghai and Shenzhen stock markets—179 shares in Shanghai and 121 in Shenzhen. The samples, which are large in size and of good liquidity, cover about 60 percent of the market value in Shanghai and Shenzhen and offer a good representation of the market. The index was based on December 31, 2004, stock figures at 1,000 points.

Trading will also be possible on the Shanghai Shenzhen 300 Index after China's stock index futures are officially launched.

There are currently 162 futures firms in China, of which 130 have obtained stock index futures qualifications. Among the 130 firms, 124 have been accepted as CFFEX members.

According to Wang, during the mock trading period, the CFFEX, futures firms and the CSRC not only guided investors concerning the trading rules, methods and skills, but also initiated risk education aimed at investors.

In the meantime, the CSRC and CFFEX have begun perfecting the stock index futures mechanism after analyzing results from the trading trial. Related departments have also researched stock index futures mechanisms from various countries, designing the Chinese index around international practice. In 2008 the U.S. Commodity Futures Trading Commission and the CSRC signed an arrangement for enhanced cooperation and collaboration designed to promote investor protection, market integrity and the supervision of derivatives trading occurring on a cross-border basis between China and the United States. The American side is also expanding training and technical aid to China.

Disputed threshold

Qualifications for investors required by the CFFEX include: the balance of the margin account must be 500,000 yuan ($73,206) or above; investors must pass a CFFEX test; and investors must have trading records of more than 20 mock trades in 10 trading days or have trading records of more than 10 commodity futures trading within the past three years.

According to Hu Yuyue, Director of the Securities and Futures Institute of Beijing Technology and Business University, at present, more than 95 percent of China's individual investors have investment volumes below 500,000 yuan, and the high threshold will block most small and medium-amount investors. The threshold will surely disappoint investors who have spent many years anticipating index futures.

"Many of my fellow investors are opposing the minimum amount for opening accounts, saying this is too high for them. It's unfair if index futures are just a game for institutional and big-time investors," said Wang.

However, Qin Bing, a researcher at CIFCO Futures Co. Ltd., thinks the high threshold is reasonable. To most investors, Qin said, stock index futures are an unfamiliar financial product, different from commodity futures and stocks in terms of investment ways, market judgment and some other aspects that carry substantial risks. The high threshold at the early stage of stock index futures' launch is appropriate, giving small and medium investors time to learn and adapt to the new investment tool, he said.

Zhu Yuchen, General Manager of the CFFEX, also stressed that the threshold is not meant to discriminate against small and medium investors, but rather to consider different investors' risk endurance.

Only with steady development at the outset and sound policies commonly accepted by society will stock index futures develop in a sound and sustainable way, Zhu said.

From the establishment of the stock index futures mechanism, people should realize China not only hopes for a smooth launch, but is also taking precautions against a repeat of the incidents of Barings Bank and Societe Generale in China. Both banks suffered considerable losses after their employees operated stock index futures businesses against the mandated rules, a mistake that forced Barings Bank to declare bankruptcy.

Warranting Concerns?

Of the many risks to consider, Wang worries most about the manipulation of the stock index futures by foreign capital. In the Chinese market, such worries widely exist.

Yong Zhiqiang, a researcher at the Research Institute of Haitong Securities Co. Ltd., thinks such worries are unnecessary, because under the current supervision mechanism, international capital has no legal channels to enter the Chinese financial market on a large scale.

According to Yong, China has not fully opened free convertibility under capital accounts. Because of strict restrictions on capital flows and market access, the only legal way for foreign capital to enter the Chinese financial market for portfolio investment is through qualified foreign institutional investors (QFII). Since the total scale of QFII is very limited, the scale of foreign capital entering the Chinese index futures market is estimated to be only $1 billion. Hedging may be the only transaction type for foreign capital to participate in stock index futures trading.

But will some international floating capital still enter the stock index futures market via underground means, such as currency smuggling, trade channels and parallel loans?

The CFFEX, according to Yong, has designed strict systems and supervision measures on index future contracts and risk-control mechanisms, leaving underground floating capital with no way to manipulate the market.

Looking at the situation historically, international floating capital usually beats markets where supervision is weak and the real economy is facing problems. These phenomena, however, do not exist in China. From the experience of overseas market development, there is no actual case where foreign capital has ever manipulated the index futures market.

As for underground illegal capital, the CSRC will cooperate with the central bank, jointly formulating an anti-money laundering framework, closely monitoring the flow of large amounts of cash in the banking system, and enforcing powerful monitoring and punishment measures against activities that could disturb Chinese financial markets.

Foreign capital participating in stock index futures trading will be limited, and only a few foreign-funded futures firms will obtain qualifications for stock index futures business.

China has opened its banking, insurance, securities and trust sectors to foreign capital, fields where there are a number of wholly foreign-owned or joint stock financial institutions. However, the opening up of futures industries lags other sectors. There are now only four joint stock futures firms in China.

According to Chinese policies, the futures market is open to foreign capital. The slow development of joint stock futures firms is mainly due to the fact that China has not opened free convertibility under capital accounts.

However, it is unlikely foreign capital will cease its efforts to enter the Chinese futures market. Once foreign capital participates in index futures trading on a large scale, it will be difficult for the supervision authority to control the risks.

How to guide foreign capital to invest in stock index futures is the question that the CSRC and other related departments should consider, because present trading rules lack restrictions on foreign-funded futures firms. On February 1, 2010, the CFFEX released a list of its new members, including J.P. Morgan Futures Co. Ltd., a futures firm with a foreign capital background.

Chronology of Chinese Stock Index Futures

September 8, 2006: The China Financial Futures Exchange (CFFEX) is established in Shanghai.

October 25, 2006: The CFFEX issues the mock trading rules.

October 30, 2006: The CFFEX begins mock trading of the Shanghai Shenzhen 300 Index.

June 27, 2007: The CFFEX issues its trading rules and related implementation rules.

July 13, 2007: The CFFEX releases the first list of futures firms that have obtained qualifications for financial futures brokerage business.

January 8, 2010: The China Securities Regulatory Commission (CSRC) announces that the State Council approves in principle to launch stock index futures, and the CSRC makes an overall arrangement of preliminary work for the launch of index futures. This process is expected to need three months for implementation.