China’s securities regulator has given the green light for qualified foreign institutions to trade a wider group of onshore derivatives, providing more hedging options for investors to balance return.

More than 600 institutional investors under the Qualified Foreign Institutional Investor (QFII) scheme could benefit from the approval, set out in a China Securities Regulatory Commission (CSRC) announcement on October 15. to trade commodity futures, commodity options and stock index options. The new arrangement begins on November 1.

Against the backdrop of the latest regulatory crackdown on different sectors, which affected the equity and bonds markets, expanding QFII’s investment scope will provide foreign investors with more hedging tools, and help attract overseas capital in the longer term, not only for arbitrage, say asset managers and consultants. 

Index options may be the most popular instruments to start with, given that exposure to Chinese equities has rocketed since early January, even as regulatory risk has proved to be a major uncertainty lately. An index option is a financial derivative that gives the holder the right (but not the obligation) to buy or sell the value of an underlying index, at the stated exercise price. No actual stocks are bought or sold.

HEDGING

Kunjal Gala,
Federated Hermes

Despite the ongoing regulatory crackdown, China has not sought to limit foreign investment in onshore Chinese assets or in Hong Kong. Investors should still make some tactical allocations to Chinese assets  although they should adjust their strategies to reflect China’s evolving focus on social stability and national security, according to a new Cambridge Associates report published on October 8.

“Stock markets in China may fear the latest rapid regulatory onslaught but investors should still see the long-term picture,” according to Kunjal Gala, global emerging markets portfolio manager at US investment manager Federated Hermes, told AsianInvestor.

Gala believes more money could flow into Chinese equities because of the new hedging tool while longer-term investors should always focus on the country’s economic sustainability.

“It might attract flow, however, the continuation of reform to sustain the growth rate of the economy is perhaps the most important driver to attract flows in a market”, he said.

BE CAREFUL

Lewis Richardson,
Broadridge

Investors also worry about other issues such as market efficiency and maturity.

“For many years, multiple types of international investors have wanted to gain access to China’s domestic commodities derivatives market. There was little progress in these markets opening up to international investment, likely slowed by the market turmoil in the summer of 2015 and an overly cautious regulator,” Lewis Richardson, director for Asia Pacific at Broadridge, a market technology, data and intelligence firm, told AsianInvestor.

He noted that the recent announcement was the next major step the market had been looking for.

“While this development will excite international investors, they will need to be wary that the Chinese derivatives market doesn’t always function the same way as international markets. For example, the Chinese markets tend to be dominated by retail and speculative trading and it is not uncommon for the regulator to intervene and change market norms on short notice, the position limits imposed on CSI 300 Index futures in August 2015 being a prime example of the latter,” he added.

Fluctuating commodity prices in recent months is another example of the volatility. (see chart below)

He also noted that, before any international investors start trading in China, they should check that their tech stack can deal with the nuances of the markets there.

"They will need to ensure that their front office platforms have the capability of connecting to the markets or their onshore brokers and will need to make sure their post-trade solutions are not only capable of processing their transactions but can also handle the very specific margin methodologies used by the Chinese exchanges," he noted. 

China also launched the first-ever margin-financing securities borrowing transactions under the scheme in January this year, providing investors with more diversified products as a way of increasing yield and hedging certain risks.

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