China’s index futures could spur its funds industry

By Samuel Shen and Edmund Klamann – Analysis

SHANGHAI (BestGrowthStock) – China’s launch of stock index futures is set to provide a long-term boost to the country’s funds industry by fostering new investment products and maybe even a homegrown George Soros.

Asia’s second-largest economy has embarked upon further liberalization of its financial markets even as Western nations are heavily scrutinizing the role played by derivatives in causing the financial crisis and are eyeing ways to control their use.

China is adopting a phased introduction of the stock index futures, to ensure their orderly growth. Still, for the country’s $380-billion mutual fund industry, it would enable rolling out products such as 130/30 funds and leveraged exchange-traded funds within two years, said Wei Zhiyu, analyst at Shenyin Wanguo Securities Co.

And for China’s private investment funds, which operate outside government supervision and are estimated to be worth more than 100 billion yuan ($14.65 billion), the derivatives will be an immediate boon.

“Index futures would make financial products more plentiful in China, where investment channels are limited,” said Ba Shusong, senior researcher at the State Council, China’s cabinet.

“The short-term impact is limited, but over time the index futures will change China’s investment landscape.”

China on Friday launched index futures — agreements to buy or sell an index at a given value on a future date — along with margin trading and short selling of shares, to provide investors with tools to manage risks in a notoriously volatile stock market.

All four of the index futures contracts rose in active trading on their first day, in an apparent sign that investors are bullish about the long-term prospects of China’s stock market, traders and analysts said.

The instrument will spawn new investment strategies by institutions that could grow into Chinese equivalents of Soros Management Co, founded by billionaire investor Soros, or Man Group Plc (EMG.L: ), analysts said.

“Index futures will generate many money-making models,” said Wu Guoping, who manages a private management fund in the southern Chinese boomtown of Shenzhen. “Players in this market will become more sophisticated and brainy.”

RISK CONTROL

China is particularly keen to build up its mutual fund sector to broaden investment opportunities for the country’s $4 trillion in household savings.

Regulators, however, appear cautious in allowing institutional participation in futures trade initially.

Financial institutions, including mutual funds, brokerages and insurers, have not yet been allowed to open index futures accounts, leaving the market dominated by retail investors.

Mutual funds will also be subject to tough regulations once they are allowed access, with draft rules capping the value of their long futures positions at 10 percent of net assets and short positions at 20 percent of stock holdings.

In addition, funds can only trade the derivatives to hedge risks, not for speculative purposes.

“The pilot stages are designed to keep potential risks and uncertainties to a minimum,” said Evian Shi, analyst at fund consultancy Z-Ben Advisors.

But index futures will prove a badly needed tool for mutual funds to manage risks, diversify products and build core competitiveness, said Ti Yuntao, analyst at Shenyin Wanguo Securities, who hailed the innovation as marking a new era for China’s fund sector.

HEDGE FUNDS

Index futures may also foster the development of a genuine hedge-fund sector in China.

Hundreds, possibly thousands, of private investment funds currently operate in China with structures similar to those of overseas hedge funds but without hedging tools.

Because they are not regulated by the government, these funds could become the most active and innovative players in China’s nascent index futures market.

“There could be countless strategies developed on the basis of index futures by such funds,” said Tang Xuan, analyst at the Shanghai Stock Exchange. “There are many players outside who are eager to jump into this market.”

Foreign institutions are also keen to trade index futures in China, according to Dean Owen, chief representative in China of Paris-based futures broker Newedge Group.

“Newedge customers all want to come to China,” Owen said. “The door is opening gradually, and I think you will see in the future more institutional investors being able to participate in index futures, like banks and hedge funds.”

Not everyone is enthused by the launch of the futures.

“Derivatives are a double-edged sword: If you bet the wrong way, you expose yourself to more risk, not less,” said Chen Zhimin, head of investment at E Fund Management Co. “We currently have no plans to trade index futures.”

Some said it may be better to wait before participating.

“Liquidity is likely to be low in China initially due to a high threshold and stringent risk control, so the time is not ripe for institutions to use complicated financial tools,” said Bai Youge, vice manager of Shenyin Wanguo Hong Kong.

Investing

(Editing by Muralikumar Anantharaman)

China’s index futures could spur its funds industry