VZCZCXRO8866
RR RUEHCN RUEHGH
DE RUEHGH #0097/01 0790743
ZNR UUUUU ZZH
R 190743Z MAR 08
FM AMCONSUL SHANGHAI
TO RUEHC/SECSTATE WASHDC 6748
INFO RUEHBJ/AMEMBASSY BEIJING 1766
RUEATRS/DEPT OF TREASURY WASHINGTON DC
RUEHGZ/AMCONSUL GUANGZHOU 1129
RUEHSH/AMCONSUL SHENYANG 1156
RUEHCN/AMCONSUL CHENGDU 1158
RUEHHK/AMCONSUL HONG KONG 1290
RUEHIN/AIT TAIPEI 0968
RHEHAAA/NSC WASHINGTON DC
RUEHGH/AMCONSUL SHANGHAI 7287
UNCLAS SECTION 01 OF 02 SHANGHAI 000097
SIPDIS
SENSITIVE
SIPDIS
STATE PASS FEDERAL RESERVE BOARD FOR JOHNSON/SCHINDLER; SAN
FRANCISCO FRB FOR CURRAN/GLICK/LUNG; NEW YORK FRB FOR CLARK/CRYSTAL/MOSELEY
STATE PASS CFTC FOR OIA/GORLICK
CEA FOR BLOCK
USDOC FOR ITA/MAC DAS KASOFF, MELCHER AND OCEA/MCQUEEN
TREASURY FOR AMB.HOLMER, WRIGHT AND TSMITH
TREASURY FOR OASIA - DOHNER/HAARSAGER/CUSHMAN
TREASURY FOR IMFP - SOBEL/MOGHTADER
NSC FOR KURT TONG
E.O. 12958: N/A
TAGS: EFIN ECON PGOV CH
SUBJECT: CHINA FINANCIAL FUTURES EXCHANGE WAITING FOR STATE COUNCIL
APPROVAL
REF: 07 SHANGHAI 251
(U) This cable is sensitive but unclassified and for official
use only. Not for distribution outside of USG channels.
1. (SBU) Summary: In a March 5 meeting with Consulate TDY Econ
Officer, China Financial Futures Exchange (CFFEX) Research and
Development Head Dr. Zhang Xiaogang and his staff provided a
status update on CFFEX preparations to launch a stock index
future. Licenses have been granted for 75 futures brokers and
mock trading has been carried out for almost one and a half
years. CFFEX is awaiting State Council approval to launch the
stock index future, after which time it will take one to two
months to finalize regulations and commence trading. Risk
averse policy makers fear that stock index future trading could
precipitate a stock market crash.
--------------------------
Building Membership, Still Waiting for a Green Light
--------------------------
2. (SBU) Though CFFEX was inaugurated on September 8, 2006
(reftel), the exchange has yet to begin trading its first
product, a stock index future based on the CSI 300. (Note: the
CSI (China Securities Index) 300 represents 300 companies listed
on China's Shanghai and Shenzhen Stock Exchanges, known as the
Hushen 300 in Chinese. Firms are included in the index based on
a formula that includes total market capitalization and share
tradability. End note.) CFFEX has been overseeing mock trading
exercises since October of 2006, which include the participation
of CFFEX's trading members.
3. (SBU) The membership of CFFEX has expanded to a total of 75
across all the membership classes. According to Dr. Zhang and
as available on CFFEX's website (), there are
12 Comprehensive Clearing Members (quanmian jiesuan huiyuan); 39
Clearing Members (jiaoyi jiesuan huiyuan); and 24 Trading
Members (jiaoyi huiyuan). All of these CFFEX members are
established as Futures Brokers and all are fully licensed.
These brokers will trade for their clients, such as securities
firms or regulator-approved insurance companies. In the future
commercial banks may be allowed as Special Clearing Members
(teshu jiesuan huiyuan, of which there are none at the present
time) and institutional investors, including securities firms,
fund managers and QFIIs will be allowed as members, but specific
regulations have not been drawn up yet for these classes of
members.
4. (SBU) After building a substantial membership and carrying
out many months of mock trading, CFFEX is waiting for a green
light from the State Council to commence actual trading of the
CSI 300 Index Futures. Dr. Zhang noted that the launch is a
political issue because by creating a means to hold short
positions, some leaders are nervous that stock market volatility
could increase dramatically and possibly lead to social
disturbances. Similarly, interlocutors at Chinese securities
firms guessed that the index futures would not be launched until
the new financial sector leadership was in place and that it was
unlikely that a single individual would advocate the launch
because of the possible negative market repercussions.
Therefore, the go-ahead would come through a process of
consensus building. One securities firm manager in Shanghai
thought it was unlikely that stock futures would be launched
before the Beijing Olympics. Once the futures are officially
approved for launch, Dr. Zhang estimated it would take one to
two months to finalize specific trading regulations and actually
commence trading.
---------------------
Managing Risk
---------------------
5. (SBU) CFFEX is aiming to limit the use of its instruments to
hedging activities, rather than as tools for speculation. As
SHANGHAI 00000097 002 OF 002
such, the exchange has initiated an investor education campaign
for its members and has established a regulatory framework to
pursue this goal. CFFEX will take a "step-by-step" approach to
its members that will entail a higher required margin on trades
until a member's reputation is established. Net short and long
positions will be allowed, but outstanding positions will be
limited to 600 contracts, which are RMB 1 million each. The
large contract size itself is designed to deter speculators as
well. Institutional investors will be allowed to apply for
higher limits on the level of contracts outstanding. All trades
will be subject to a pre-execution credit check, and margins
will be collected on both sides of the trade, even if a firm
holds both long and short positions.
6. (SBU) Oversight for financial futures trading will encompass
the spectrum of regulatory agencies. The Futures Supervision
Department of the China Securities Regulatory Commission (CSRC)
will oversee trading activities. The CSRC established a
third-party institution in 2006 to facilitate futures trades,
the China Futures Margin Monitoring Center. Each trading
institution will be overseen by their respective regulators, for
example, the China Banking Regulatory Commission (CBRC) will
oversee commercial banks' trading activities.
-----------------
History Lends to a Cautious Approach
-----------------
7. (SBU) When asked about China's previous experience
introducing financial futures in the 1990s, which resulted in a
bond market crash, Dr. Zhang and his staff drew contrasts with
the present context for futures trading and the 1990s. To begin
with, in the previous decade the legal framework for futures
trading was very weak, with no regulations to support trading
activity. The authorities have established and strengthened
regulations, beginning with Futures Trading Regulations passed
by the State Council in 1997. The 1990s bond market crash is
one reason that the current framework for futures trading leans
more towards risk mitigation than efficiency. Dr. Zhang's staff
noted that the smooth and constructive performance of the
commodities futures market has helped to lessen concern. But
risk averse authorities with an incomplete understanding of
complicated financial derivatives err on the side of caution.
-------------------
Investors Eager for Stock Hedging Instruments
-------------------
8. (SBU) Dr. Zhang and his staff noted strong interest among
institutional investors for stock hedging tools. This sentiment
was echoed by a director at a foreign-invested securities firm,
who said that the firm's clients were very interested in the
proposed index future. Currently investors can try to create
proxy hedges with instruments in the Hong Kong and Singapore
markets, but these offer imperfect coverage and limited
liquidity. Dr. Zhang thought that liquidity in China would be
ample, given a demand for both long and short positions.
9. (SBU) Dr. Zhang previewed traded financial derivatives that
might follow the stock index future. His team is currently
researching exchange-traded stock index options and treasury
bond futures. They have done extensive research on these types
of instruments in U.S. markets.
JARRETT