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New China options to pave way for open commodities trading
Regulator approval comes after surge in volumes and volatility in 2016

As China prepares to introduce its first options contracts for commodities trading, the head of one of the country’s leading bourses for raw materials has shrugged off fears that the move will add to the extreme volatility in commodities seen in 2016.

“We [in China] are behind international markets because we have too few tools, too few products,” says Li Zhengqiang, chairman of the Dalian Commodity Exchange, adding that introducing more products and new instruments like options will help hedge risk, not add to it.

Regulators approved the launch of the country’s first commodities options last month, giving the nod to Dalian to launch soya meal contracts later this year, and for white sugar options at rival Zhengzhou Commodity Exchange.

The approvals come after a year of record volumes in Chinese commodities futures trading. Explosive gains in Chinese steel and coal contracts in 2016 took international markets by surprise and lifted prices globally. The boom in futures trading alarmed regulators, who feared a repeat of the stock market turmoil experienced the year before.

In 2016, the Dalian exchange saw trading volumes jump almost 50 per cent from a year earlier to Rmb61.4tn, a threefold increase from 2010. Trading volumes on China’s three exchanges reached a combined record of Rmb177tn last year.

Mr Li, who wants the DCE to become one of the international centres for commodities pricing and risk management, says there is a growing consensus among Chinese officials of the need to embrace new financial products. China launched options on an equity index in 2015.

In an interview in the northeastern port of Dalian, he said: “Society used to worry about new products, and officials did as well. Now they basically don’t have doubts any more.”

Introducing options is first of the exchange’s “three big strategic missions”, he says, along with allowing foreign investors to trade directly in Chinese futures, and introducing swaps contracts.

Options — which give the right but not the obligation to buy a financial contract in the future — would allow greater hedging flexibility for Chinese corporations; swaps would allow producers and consumers greater protection against commodity price volatility.

Both products have boosted volumes and profits for exchanges worldwide, but China’s conservative regulators had worried they would introduce even more volatility into domestic markets already known for their wild price movements.

“We are behind international markets because we have too few tools, too few products. And another disadvantage: at the moment, we are still a relatively closed market,” he says.

Foreigners can set up a China-registered company to trade Chinese futures, but the process is cumbersome. Mr Li wants overseas investors to directly trade Dalian’s iron ore contract and possibly its palm oil contract. Regulators have yet to sign off.While China is the leading buyer of most resources, including soyabeans, iron ore and oil, its futures markets are at a nascent stage, and Beijing is still feeling its way out of the state planning era. Only three years ago, it declared in policy reforms that markets should play a “decisive” role in allocating resources.

Mr Li is pulling for China’s transformation into an international financial centre equal to its economic heft. International traders already pay attention to China’s commodities exchanges — Dalian and the country’s two other commodities exchanges in Shanghai and Zhengzhou — which for several years have set the direction of international markets for metals and grains.

But he understands the need for caution. “For China to launch any new tool, any reform, it needs a suitable environment. And what does that mean? It needs the market to be relatively stable.”
Mr Li believes China’s three exchanges will someday rival the LME or CME as global players. But for now, they must balance their mission to increase trading volumes with averting a socially destabilising crash, he says. “Our responsibility is to keep the market stable. The burden on us to dampen market risk is greater.”