The move by China’s securities regulator to allow qualified foreign institutional investors (QFIIs) to trade stock index futures on the China Financial Futures Exchange has been welcomed as a step in the right direction.

The China Securities Regulatory Commission (CSRC) published draft proposals towards the end of last month, with a consultation period set to expire on February 12. If approved, it will be the first time that foreign investors will be able to short the A-share market.

“It is the first step in the right direction in the sense that [China’s] capital market is becoming more professional,” says Ronald Chan, head of equities for Asia at Manulife Asset Management, which received its initial $200 million QFII quota last June and plans to apply for a second quota this June.

However, the CSRC is only proposing to permit hedging and not investments for speculative or arbitrage purposes. Investors would also not be allowed to use index futures as a means to sell financial derivative products in offshore markets.

To limit the potential risk of increased stock volatility, the CSRC is proposing to limit the daily value of futures contracts that a QFII investor can hold, while the daily transaction volume may not exceed the quota approved by the State Administration of Foreign Exchange (Safe).

QFIIs may choose up to three domestic futures companies to open trading accounts, but only one custodian bank to place its security deposit.

Custodian banks and futures firms will be required to supervise QFIIs’ stock index futures trading activities and report to the CSRC any findings of irregular or illegal trading activity. Custodian banks will also need to send regular reports of QFIIs’ trading activities to the CSRC.

Asked if he felt the rules were overly restrictive, Chan refers to China’s need to take baby steps as it opens up. “I don’t expect [the China Financial Futures Exchange] to be fully internationalised into one you can find overseas,” he says.

But he expects regulatory relaxations to continue and more investment quotas for hedging purposes to be issued. “This is just the first step of many steps,” he adds. “We will be hearing more from the CSRC and Safe.”

Stock index futures were launched in China last April, the first financial futures product in the country.

“To ensure smooth operation, we follow the principles of ‘gradual opening-up, limited participation and manageable risk’ when designing the scheme for QFII to trade stock future index”, the CSRC says in a statement.

Safe had granted quotas worth about $19.72 billion to 97 QFII funds by the end of 2010.