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China's mrkt buzz with talk of reform

From stocks to bonds to futures, reform has become the catchword for China's capital markets after the delinking of the yuan from its US dollar peg.

india Updated: Feb 23, 2006 11:48 IST

From stocks to bonds to futures, reform has become the catchword for China's capital markets after the delinking of the yuan from its US dollar peg in July created new risks for a globalising China Inc.

Capital market reforms are expected to be a hot topic on the sidelines of the annual March session of the National People's Congress, China's parliament, which will endorse a Communist Party blueprint for development for the five years to 2010.

A flurry of new financial instruments and increased access to foreign markets are being considered. The aim is to allow China's firms to hedge risk as they become more integrated with world markets after an overhaul of state industry that started in the 1990s.

"It has become increasingly urgent for the government to establish risk-control mechanisms for companies," said Dong Dezhi, analyst at top foreign exchange lender Bank of China.

In the busy months since China revalued the yuan by 2.1 per cent and unpegged it from the dollar, it has launched foreign exchange forwards and let market makers set the yuan's trading rate.

Beijing has allowed interest rate swaps, and will soon allow investors to borrow against stock holdings -- shaking up the operating environment for firms that had previously operated under a static currency and decades of fixed interest rates.

Enter the Financial Derivatives Exchange. Jointly owned by China's two stock exchanges and three futures exchanges, the new exchange could throw open its doors as early as this year.

Dealers and analysts said bond and interest rate futures could be the first products to be launched on the planned exchange, with stock and bond index futures, interest rate and exchange rate derivatives to follow.

China's mainland stock markets could use any boost that index futures might bring. Their capitalisation has dived to $430 billion from more than $600 billion at their 2001 peak.

"In addition to the stock market, China's bond markets have developed rapidly in recent years and increasingly need hedging tools," said analysts Cao Jianming at Orient Securities.

Outstanding bonds were valued at 7.3 trillion yuan by the end of 2005, up from 3.7 trillion yuan at the end of 2003.

Destined for Shanghai, the new financial derivatives exchange does not yet have a fixed address. But neither did the Shanghai Futures Exchange when it was born in a Shanghai hotel in 1999.

Opening up

Earlier experiments have bred caution in Chinese regulators. A casino-like atmosphere emerged in the early 1990s, when China boasted about 50 futures products -- covering such diverse fare as peanut kernels, dry kelp, beer barley and yarn -- and numerous local exchanges.

But China suspended treasury bond futures in 1995, after a short squeeze and subsequent crash wiped out at least 1 billion yuan ($124 million) in government money in a single day.

A decade later, Chinese firms' debts and profits are increasingly tied to international movements in currencies, interest rates and commodities. China is set to almost fully open its financial sector to foreign competition by year end, in line with World Trade Organisation commitments.

The annual gathering of parliament is largely ceremonial, with delegates approving policy and personnel changes already agreed by party leaders. But proposals for the battered young markets are often subjects of hot debate.

China is expected to name the new derivatives exchange's executives shortly after a management reshuffle in the industry.

State media have named Fan Fuchun, current vice chairman of the China Securities Regulatory Commission, as the most likely candidate to head the new exchange.

Zhao Zhengping, former vice director of the regulator commission's supervisory department, became president of the Zhengzhou Commodity Exchange this month, while the exchange's previous president, Wang Xianli, is now chairman.

The Shanghai and Dalian commodity exchanges are also expected to announce management changes, with some officials likely to rotate to the regulatory commission and the new exchange.

China is also slowly opening legal channels for firms to trade commodities overseas, and for brokerages and banks to offer clients more complex products, such as gold, bond forwards and foreign currencies.

The newest exchange could also galvanise China's futures exchanges to push for approval to launch options on their most popular futures contracts.

"It's in the interest of the exchanges to push for the options products quickly," said an exchange official. "Otherwise, although the derivatives exchange in the long run will bring a clear boost to trading volumes, in the short run it may steal their thunder."

First Published: Feb 23, 2006 11:41 IST