China readies for resumption of treasury bond futures

Individuals and private funds are expected to lead the pack into China treasury bond futures, offered for the first time after an 18-year hiatus.
Headquarters of the CSRC
Headquarters of the CSRC

Non-institutional investors are readying for the resumption of trading in treasury bond futures in China after an 18-year hiatus sparked by a short-selling scandal.

The thinking is that qualified individuals and sunshine funds — the prototype of hedge funds in China — will be the first to take up the offer, with securities firms only re-entering the market once it has achieved sufficient depth and liquidity.

Late last week the China Securities Regulatory Commission (CSRC) announced that trading in government bond futures would be relaunched in some two months’ time — indicating a start date of September.

And yesterday the China Financial Futures Exchange (CFFEX) published a consultation paper outlining strict new trading parameters, with an increased emphasis on risk control.

Trading in treasury bond futures was halted back in May 1995, but in February last year trading was resumed on a concentrated and small scale for institutional investors only.

However, demand has since been strong, with average daily trading volume amounting to Rmb42.5 billion ($6.9 billion) in 2012. It is estimated 13,000 institutions took part in this mock trading.

This process has familiarised authorities with the needs of investors, with the CFFEX now launching a brief public consultation process to July 14 to incorporate any final amendments prior to a broad market relaunch.

Authorities are now proposing to limit price movements in treasury bond futures to 2% either up or down, with any movement outside of that resulting triggering a trading halt.

The exchange stresses that this cap is to ensure market stability, noting that 99.7% of China’s treasury bonds have seen price movement of less than 1% since 2007 on a spot-price basis.

Further, authorities are proposing to set a minimum margin for trading at 2% of a futures contract’s total value — stricter than the global average of less than 1.5%. For instance, it is set at 1.1% for the Chicago Mercantile Exchange and 1.25% for Euronext.

A senior manager at one futures firm, which participated in the mock trading, notes that the less investors pay at the outset of a futures contract, the higher the leverage will be — which is something the authorities are eager to keep a lid on.

“The main purpose [of the new cap] is to reduce leverage and risk, particularly for treasury bonds which can become too concentrated in one investor’s hands,” he said, noting that this will permit leverage of around 50 times.

Moreover, take into account the fact that brokers will require an additional margin, typically 50%, that would increase the minimum margin for trading to 3% and further restrict leverage.

It is expected that four-to-seven-year treasury bonds — amounting to Rmb1.9 trillion outstanding — will be favoured for futures trading on account of their deeper liquidity.

The ban on futures trading in treasury bonds was imposed in 1995. Speculation had mounted at the start of that year that the finance ministry would compensate holders of treasury bonds amid a soaring inflation rate, triggering investors to build up long and short positions.

When the ministry announced it would raise interest rates to subsidise government bondholders, Wanguo Securities as the biggest short-seller was a big loser. Just minutes before market close, it tried a Rmb200 billion sell order in an attempt to lower the bond price that did not go through on account of an insufficient margin deposit.

The Shanghai Stock Exchange subsequently cancelled transactions made in the last 20 minutes of trading, at a cost of more than Rmb1 billion to the government. Wanguo was declared bankrupt, its founder Guan Jinsheng was sentenced to 17 years’ jail for bribery and embezzlement. The firm was merged with Shenyin.

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