Derivatives, futures, short selling. In the West, these are terms associated with the highly complex financial instruments that nearly brought the global economy to ruin. In China, they are the future of a more sophisticated (and predictable) financial marketplace.
On January 8, China’s State Council gave approval (in principle) for the launch of stock market index futures. Margin trading and short selling will also be allowed.
The introduction of these hedging tools could significantly alter the trading strategies of investors. Up to now, the Chinese investor could only buy and hold. This is fine when shares increase in price, but when the market starts to drop, investors can only cut losses by selling. That often leads to an increase in the speed of the fall, and overall volatility in the market.
Investors will now be able to take short positions and benefit from downward momentum. And as a result, volatility should lessen. That can only be a good thing in a market that was up 80% in 2009 after dropping 65% the year before.
The index futures are expected to be based on the CSI300 Index, a representative list of companies traded in Shanghai and Shenzhen.
“Once the stock index futures are launched, institutions will undoubtedly increase their positions in large-caps to seek a bigger say in pricing the derivatives. Index heavyweights will then serve as a market stabiliser,” Zheng Weigang of Shanghai Securities told Reuters.
The stocks that will benefit most are heavily weighted companies on the index such as Bank of Communications, China Merchants Bank and Ping An Insurance.
Analysts say that the A-share market could do with some upward pressure, following the launching of a series of IPOs. Government measures to rein in market liquidity are also expected to push the market down in coming months.
Although the new financial instruments are no surprise – they have been on the cards since 2006 – they will not lead to overnight changes. Up to three months will be spent preparing the new futures exchange. And once the products are launched, investors are expected to take a wait-and-see approach.
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