Mature financial futures market needed

In its fervent bid to realize its dream to be a world-class financial center, Shanghai has established a market for almost everything. But the various elements that are essential to the development of those markets are mostly absent. As a result, the markets are prevented from fulfilling their designed functions.

The 3-year-old index futures market is a case in point.

The market, opened in April 2010, is still limping along without making much of an impact on the stock market. The volume of trading in index futures is tiny compared to the size of the stock market. As such, it is seen to have little value for hedging by institutional investors.

In a move apparently to inject new life into the market, the authorities earlier said they would open the market to QFII investors, including some of the largest global financial institutions. But it remains doubtful if these big fish are willing to play in a market that is too illiquid to do much meaningful hedging.

As we all know, trading in financial futures is a zero-sum game. Hedgers alone don't make a market. There has to be enough counter trade from risk takers, or speculators, who take an opposite view to that of the investors who feel the need to hedge their holdings against a possible downturn.

But in Shanghai's financial circles, speculation is a dirty word. It conjures up images of shady people with lots of money plotting in basement offices to profiteer by cornering the supply of anything from property, coal, white wine, pork or garlic.

Many Chinese investors and commentators who have taken up the mantle of protector of investors' interests have expressed their concern that index futures trading could provide an effective tool, or an irresistible opportunity, for the stock market sharks to manipulate share prices for profit. In Hong Kong, which hosts an active market for financial futures, share prices often move irregularly on or around index futures settlement dates.

In a free and an open market, such irregularities can be expected to be quickly ironed out and equilibrium reestablished. Investors who are seeking to hedge their risks and speculators who are taking risk in the hope of big gains should be allowed free play in the market within the regulatory framework.

In Hong Kong and other financial centers, banks are the major players in the financial futures market which enables them to design many different derivatives products to suit the investment needs of their high-net-worth clients and funding needs of their corporate customers. Most of these derivatives products are tailor-made to fit the specific needs of individual clients. Some are packaged and sold in smaller lots to retail customers for investment purposes.

In times of uncertainty, many high-net-worth customers will ask their bankers to design for them derivatives products using index futures to lock in their gains instead of unloading their holdings, which could cause erratic price movements. For that reason, an active index futures market can help minimize the risk of a selling stampede by jittery investors when their confidence is sapped by a cloudy economic outlook.

We are sure that the architects of the Shanghai index futures market are well aware of its function. They need to take bold action to increase market liquidity so that it can realize its potential.

Allowing foreign participation in index futures trading is a positive step in the right direction. City financial authorities can go a step further by encouraging these institutions to offer index futures-based derivatives products to help investors to minimize potential risks through hedging, or maximize potential gains through leveraging.

That's what a futures market is for.

(China Daily 02/04/2013 page9)