Developing derivatives in China

At Societe GeneraleÆs Derivatives Forum in Shanghai the movers and shakers in the mainland market discussed how to expand the market, but also warned of the dangers.
A veritable whoÆs who of mainland regulators and central bankers lined the first two rows of Societe GeneraleÆs Derivatives Forum at the Regal International East Asia Hotel in Shanghai on Friday (31 March).

About two hundred local bankers, security house and insurance company executives and fund managers rounded out the rest of the audience who gathered to discuss how to develop derivative products in China.

The main points the Societe Generale speakers continuously drove home were that encouraging clear guidelines and educating investors would help develop the business, which would be beneficial to the country because it could help attract more capital investment.

ôChinaÆs opening financial market, due to the WTO rules, means thatÆs ChinaÆs financial problems will be exposed to the world,ö said He Qiang, a professor in the department of finance research at the Central University of Finance. ôThe lack of a developed capital market is one problem but developing the derivatives market can help develop the capital markets.ö

Specifically, Bernard Desforges, Societe Generale's Head of Equity Derivatives for Asia Pacific, said, "While 2005 in China was the year of Chinese yuan-denominated forwards and currency swaps, we believe 2006 will see increasing appetite in China for equity derivatives amongst other areas of development."

But the speakers were û surprisingly - frank about the dangers.

One of the big problems in ChinaÆs markets, perhaps most obvious in the burgeoning warrants trade, is that thereÆs still quite a bit of speculation going on, which sometimes has driven the price of warrants up higher than the underlying stock. To avoid having a growing derivatives market exacerbate widespread speculation, the commentators called upon the regulators to actively monitor the industry.

Another potential stress-point is that if the derivates market develops too quickly, China could see a fall in the stockmarket as investors put their money elsewhere. And so, more investors are needed in order to maintain the liquidity.

How to get more investors? The message that came from the conference: open the market more to foreigners and educate the local market on the risks so they feel comfortable investing their money.

ôThe investment trend has moved from the big institutional investors, whom initially were the only players, to the smaller institutional investors to individuals, which demonstrates there is demand,ö said Pierre Xiang, deputy general manager, international department, of China Everbright Bank. ôWhatÆs interesting is you increasingly see individual investors understanding complicated structures introduced by foreign banks. But we still need to continue educating the market.ö

As more complex renminbi-denominated products come to the market and local investors seek higher yields, the need for education grows, added Xiang. Plus, if interest rates remain low, itÆs inevitable that structures with no capital guarantees û and thus high returns for the risk û will become even more popular, fuelling the need for customer education.

ôKeep in mind that banks are required to explain fully the risks,ö said Xiang. ôBut IÆm not sure all of the banks are doing this well. There are some, who probably prefer to talk mostly about the advantages.ö

Such comments prompted audience members û particularly those who are trying to sell the products in the local market - to ask how do you suggest educating the public? Societe Generale managers were quick to point out, of course, that such forums as this one were a start. But the French bank also noted that it provides local partners with interactive web access offering daily pricing and product information that serves as continuing education.

The dangers posed in the derivatives world of a lack of regulatory control and an uneducated investing clientele are well known globally. It remains to be seen if those regulators in attendance at this event and those managers prepared to sell the products take heed of the advice.

Should you want a copy of the conference presentations, please feel free to contact [email protected].

Click here to download the conference agenda

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