China: Government bond futures return after 18 years
Risk-control measures in place; further step in economic liberalization.
Following an 18-year hiatus, China government bond (CGB) futures contracts have begun trading on the China Financial Futures Exchange(CFFEX), marking another step towards the modernization of China’s capital markets. The long absence came after a trading scandal in 1995 led to the contracts being banned.
Futures for settlement in December 2013 – the shortest dated – were the most actively traded of the three contracts available on their first day. The futures opened at Rmb94.22 ($15.40) from the exchange base price of Rmb94.168. The March 2013 contract and June 2014 contract were both up less than 0.3%.
Contract specifications released by the CFFEX stress that contracts are limited to move a maximum 4% on either side of the benchmark prices on listing day, and 2% in either direction from the second trading day. In addition, each CGB futures contract has a face value of Rmb1 million based on the underlying asset being a hypothetical five-year 3% fixed-coupon CGB.
Strong risk-control measures have been introduced by regulators. “The widely anticipated reintroduction of the CGB futures is a major financial reform initiative this year,” says Linan Liu, strategist at Deutsche Bank based in Hong Kong. “The China Securities Regulatory Commission has established a cross-ministry coordination mechanism with the ministry of finance, the People’s Bank of China, the China Banking Regulatory Commission and the China Insurance Regulatory Commission to ensure that adequate regulation is in place to support market activities and control market risks.”
The first CGB futures contract was introduced in December 1992 on the Shanghai Stock Exchange. But trading was banned on May 17 1995 after a scandal over highly speculative trading broke out.
On February 23 1995 – eight minutes before the close of the trading day – Wanguo Securities, China’s biggest brokerage firm at the time, made Rmb140 billion-worth of sell orders for one contract, causing the price to dive. The matter was quickly discovered by the Shanghai Stock Exchange, where the futures were traded, and all related transactions by the brokerage were annulled.
Wanguo’s ex-president, Guan Jinsheng, was found guilty of deliberately breaking the rules and was sentenced to 17 years’ imprisonment. Wanguo was later forced to merge with Shanghai Shenyin Securities Company.
But there are other risks involved with the absence of commercial banks and insurance players in the bond futures market. As it stands, the institutions able to trade CGB futures contracts include securities firms and their clients, but other larger domestic institutions such as commercial banks and insurance companies remain on the sidelines. “[Their absence] in the bond futures market implies potential risks in the early stage of CGB,” says Liu. These include low transaction volume and low liquidity of the futures contract, a risk of a cash-bond squeeze, and pricing dislocation between the cash-bond market and the bond futures market. However, “the current arrangement suggests regulators are taking a step-by-step approach in granting access to the bond futures market in order to better manage market risks”, says Liu. “I expect commercial banks to enter the market at a later stage.”
Following the election of Li Keqiang as premier of the People’s Republic of China, the authorities in Beijing have ramped up the path to economic liberalization.
As well as the reintroduction of CGB futures, the authorities pulled limits on bank lending rates and increased the investment quota of qualified foreign institutional investors (QFII) to $150 billion from $80 billion in July. However, the government has made little progress towards scrapping limits on deposit rates, one of the most important measures towards economic liberalization, according to some experts.
Separately, interdealer broker Tullett Prebon unveiled a new pricing service for Chinese bonds. The service comprises pricing data across the liquid interbank bond market. Instruments covered include government bonds, PBOC bills, corporate commercial paper and medium-term notes.
Frank Desmond, managing director at Tullett Prebon Information, says: “The rapid growth of the Chinese bond market is driving demand for ever higher standards of transparency and independence. With a value outstanding of Rmb22.6 trillion, it is now one of the largest bond markets in the world. Further growth is expected, particularly in relation to corporate bonds, and as the market evolves access will be enabled by niche, sophisticated data.”
Andrew Reeve, head of Asia at Tullett Prebon Information, adds: “As the Chinese market opens up and becomes more important to financial organizations the world over, the need for independent pricing and valuation information for government and corporate bonds will only increase. The liberalization of the renminbi and its rise as a potential reserve currency are also likely to drive increased foreign investment in the future.”