The Market Corner: The Month in Review "Trading Futures in China, finally happening?"

By Filippo Lecchini

Trading Futures in China, finally happening?

For several months now the rumor has gone around that China is finally ready to open its commodities futures exchanges to foreigners. At the end of September the China Securities Regulatory Commissions (CSRC) announced that progress is being made and a change should be imminent.

It is hard to tell exactly what total notional and volumes are being currently exchanged but the opportunity should be significant. China has a fast growing middle class that in an expanding economy has been able to access higher levels of consumption and savings, rapidly catching up to Europe and the US. What have also been instrumental to a rapid expansion are the capital controls that by not allowing funds to move abroad channeled the growing liquidity into domestic initiatives. As discussed a few months ago that is one reason for the crypto currencies success in China as well as the September crackdown, which among other issues was an attempt at blocking capital outflows, which Bitcoin for example made possible outside the Government’s control.

Opening to foreign investors is not the only goal of this initiative as the Chinese exchanges are actively planning to compete with futures exchanges in the US and Europe. Iron Ore is certainly an area of development: China has already a prevalent role in the physical market and western investors are actively trading the contract on the Singapore Exchange, which so far has been as close as one could get to “trading China”. Taking over that role would be a natural development for the Chinese exchanges.

And then expansion. The new flagship project is a crude oil contract denominated in yuan renmimbi that will openly challenge the supremacy of the Brent and West Texas Intermediate contracts. A crucial aspect that should not be overlooked is the currency piece. A contract denominated in yuan would weaken the stronghold of the US, reinforce the role of the chinese currency as an international mean of payment and make more desirable for foreigners to hold yuan reserves.  Theoretically there is certainly a demand for that feature because at least countries like Russia, North Korea or Iran would have a way to circumvent the international sanctions and avoid the control of the United States, even though that might not be allowed eventually. At the time of writing a lot of details still need to be worked out, including a possible gold convertibility feature. That would allow investors to be paid in gold and avoid currencies altogether.

Regardless of how the details get finalized there is little doubt that China is moving toward more integration with the international markets. The raising levels of income, wealth and business knowledge are feeding into the appetite for expansion and competition for an economy that has turned decisively toward capitalism. An always transforming government led version of it, but capitalism nonetheless.

Looking ahead:

The last FOMC meeting for 2017 is scheduled on December 12-13. The question that has been lingering for at least six month will be finally answered and we will find out whether the FED will opt for a third rate hike in 2017. The other even more anticipated decision revolves around the Tax Reform that the Majority in Congress and the White House are hoping to sign into law by the end of the year. The process has just begun and some differences seem insurmountable, but is fair to say that major pieces of legislation almost always seem to have an arduous path to the final approval.  

RISK DISCLAIMER: Trading in futures products entails significant risks of loss which must be understood prior to trading and may not be appropriate for all investors. Past performance of actual trades or strategies cited herein is not necessarily indicative of future performance. The information contained herein is provided to you for information only and believed to be drawn from reliable sources but cannot be guaranteed; Phillip Capital Inc. assumes no responsibility for errors or omissions. The views and opinions expressed in this letter are those of the author and do not reflect the views of Phillip Capital Inc. or its staff.