China: Regulators tinker, futures trading plummets
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China: Regulators tinker, futures trading plummets

Predominant retail investors deterred; Stability favoured over market growth

Measures taken by Chinese regulators to try to diversify the investor base of the heavily retail-driven Chinese futures markets have caused volumes on the country’s exchanges to drop dramatically.

fall in volume of contracts over six months on Shanghai Futures Exchange

Shanghai Futures Exchange has been the most affected, with the volume of contracts traded and/or cleared falling by 57.2% between January and June 2011 compared with the same period in 2010, according to broker Citic Newedge. Volumes on the Zhengzhou Commodity Exchange fell 4% in the same period and those on the Dalian Commodity Exchange by 14.6%. The measures responsible for this decline in activity, local brokers say, include a cap of 500 on the number of order cancellation messages any client can send in a day, and an increase in transaction costs.

"The market in China is about 95% retail," says a senior local broker, "and very sentiment driven so it does affect prices. There aren’t hedge funds to take the other side of trades as you have in other markets, and the banks can’t participate. The regulators have noticed this imbalance and are trying to diversify the client pool."

The source says there are some 115 million futures accounts in China, many of which are dormant. The vast majority of these are owned by retail investors for whom the barrier to entry has been low. With the government’s latest five-year plan devoted to combating inflation, the government might be concerned about the potential effects of retail speculation on commodity prices.

The increase in transaction costs in particular appears to be aimed at raising the barrier to entry for futures trading, in an effort to discourage new retail investors. As several sources point out, China’s exchanges are state controlled rather than profit-driven private companies and therefore have different priorities to those of their foreign counterparts. Rather than prioritizing growth of trading and therefore profits above all else, the goal is to promote market stability and help the government’s overall economic ambitions.

A secondary effect of the measures is to strongly discourage high-frequency trading strategies. "I could bring in a bunch of high-frequency and algo clients right away to add liquidity," says another broker based in Shanghai, "but the exchange is not interested. We get the consistent message that they are happy with the current number of accounts."

The cap on order cancellations in particular seems designed to thwart high-frequency trading, a strategy that relies on being able to flood an exchange with buy-and-sell orders that are often then cancelled before the deal is executed. The strategy has been blamed by some for exacerbating sudden market crashes and that fact might further explain China’s reluctance to embrace it given the country’s stability-first policy.

China’s futures market is regulated by the China Securities Regulatory Commission, with contracts being traded on the three exchanges mentioned above and on the Shanghai-based China Financial Futures Exchange.

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