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CSI 300 Futures - China

CSI 300 Index Futures
A Shanghai trader rejoices after
closing a winning trade.

Foreigners Eligible to Buy China Stock Index Futures.

BEIJING, (Reuters) - China's securities regulator has unveiled draft rules to let foreign
investors buy stock index futures under the country's qualified foreign institutional investor
(QFII) scheme.

China launched index futures - agreements to buy or sell an index at a set price on a future
date - last April to provide investors with a badly-needed tool to manage risks in the
country's volatile stock market.

Under the rules published by the China Securities Regulatory Commission on its website
(www.csrc.gov.cn), foreign investment in the stock index futures would be restricted to
hedging activity.

The draft rules are open to public comment.

The daily holdings of index futures of foreign investors cannot exceed their investment
quotas and the same ceiling would be applied to the daily turnover, according to the rules.

A maximum of 10 trading days would be given for investors to adjust their holdings to safer
levels if the market was too volatile for them to meet the daily requirements.

The regulator said it would strictly supervise foreign investment in stock index futures to
curb potential risks.



Day Trading Still Alive, Outsourced to China

from the NYTimes
BEIJING — Before the opening bell sounded on the New York Stock Exchange on a recent Tuesday, a group of
fresh college graduates clocked in at a small trading firm on the outskirts of this capital city.

Shiho Fukada for The New York Times
King Chan, an American citizen, left a job at JPMorgan to work at Lazer Trade in China.
They were hired to engage in rapid-fire stock trading with some of the world’s most powerful investment houses in
New York, London and Tokyo, and they were instructed to be alert.

“The market could be volatile today,” King Chan, the general manager at the firm, Lazer Trade, shouted to the group
during a pep talk. “Be careful at the open. And don’t take dumb risks!”

Mr. Chan’s day trading shop is one of many that have sprung up in and around China’s major cities in recent years.
Trading firms based in the United States and Canada are recruiting inexpensive workers in China and teaching
them to engage in speculative trading — which means repeatedly buying and selling shares listed on the New
York Stock Exchange and Nasdaq, hoping for quick profits.

By some industry estimates, as many as 10,000 people in China are doing speculative day trading of American
stocks — mostly aggressive young men working the wee hours here, from 9:30 p.m. to 4 a.m., often trading tens of
thousands of shares a day.

“Trading groups have exploded into China,” says Stephen Ehrlich, chief executive at Lightspeed Financial, a New
York company that sells trading software to firms operating in China.

China prohibits its citizens from using Chinese currency to buy or sell shares of companies listed on foreign stock
exchanges, though there appears to be no prohibition against trading stocks for an account owned by a foreign
entity.

That legal gray area has enticed several American and Canadian trading firms to set up shop here, at least partly
to cater to wealthy clients seeking more diverse investment options.

Securities experts are puzzled by the operations. They question how the firms can profit by using inexperienced
traders. They also wonder aloud whether the use of traders in China violates American and Canadian securities
laws.

“This is a jurisdictional mess for the U.S. regulators,” says Thomas J. Rice, an expert in securities law at Baker &
McKenzie. “Are these Chinese traders essentially acting as brokers? If they are they would need to be registered in
the U.S.”

Officials at the Securities and Exchange Commission and their counterparts in Canada and China declined to
comment when asked about the growth of day trading in China. The New York Stock Exchange and Nasdaq also
declined to comment.

A spokesman for Swift Trade, which provides software to Lazer Trade and takes a cut of its trading profits, insisted
the China operation was registered properly and was entirely legal. Two other firms with day trading operations
here, Hold Brothers and Title Trading, declined repeated requests for interviews.

Some of these firms say they can profit from trading operations in China through a combination of cheap overhead,
rebates and other financial incentives from the major stock exchanges, and pent-up demand for broader
investment options among China’s elite.

Most of the firms say they put up their own capital or capital from private investors in the United States or Canada to
open an affiliated trading shop in China. They hire young Chinese to trade for them — often with no standard salary
but a promise to share in any profits.

Peter Beck, a founder of Swift Trade, a Canadian firm with about 1,500 traders in China, said his operation was
thriving and that the firm got a share of the trading profits.

“Our clients — they open an office, give us the money and then hire people to trade for them. That’s our structure,”
he said in a telephone interview.

Swift Trade is considered one of the pioneers in the outsourcing of day trading. It grew initially by offering brokerage
services in Canada and then by hiring Canadians to trade the firm’s capital from its Toronto headquarters. The
company offered modest salaries to traders along with profit-sharing deals.

But after 2001, when American exchanges began pricing shares in decimals instead of fractions, the trading
spreads tightened and profits plummeted. As a result, many day traders — who benefited from large spreads as
much as from price swings — were forced to quit.


With fewer traders using its software or sharing their trading profits, Swift pushed into Asia. The firm opened a
training center in China and encouraged some Canadian traders with Chinese roots to move to China to set up
and manage a Swift-affiliated day trading firm.

The business took off, and by 2007 Swift and other day trading firms, like Title Trading and Hold Brothers, were
offering services to thousands of day traders — often through accounts registered by wealthy Chinese or by
expatriates from the United States and Canada.

One of those risk-takers is Mr. Chan, a 25-year-old American citizen who says he left a job at JPMorgan in the
United States last year to invest and manage Lazer Trade.

Some 200 people have applied for jobs at the company in the last two months alone, Mr. Chan said. Turnover is
high, with workers typically moving on after four or five months. Very few stay for more than a year.

At a Beijing affiliate of Title Trading, the manager — who asked not to be named because he worries about the
chances of finding another job if his operation fails — said he moved here from Canada because of the
advantages of operating a trading desk with Chinese who were willing to start trading for little or no salary.

“Before, when a trader could earn $4,000 to $5,000 a month, Canadians wanted to do it,” he said. “But if it’s $1,000
they won’t. So it’s like anything else: outsource to China.”

College graduates typically earn $300 to $400 a month in China, but labor experts here say that as the job market
for white-collar workers has weakened, more of them have been willing to take their chances in jobs with no
guaranteed pay but with opportunities to share in profits.

If the traders make a profit, they keep between 10 and 50 percent, with the rest split between the trading firm and
the investor. (If the traders produce a loss, they risk the firms’ clients and possibly their own jobs.)

John C. Coffee Jr., a securities law expert at Columbia University, says the arrangement amounts to a huge and
odd brokerage fee.

“It’s extraordinarily high compensation. If this were happening in the U.S., the fees would be excessive,” he said in
a telephone interview. He added that even if the traders could outperform the overall market, “The transaction fees
would eat up some of the gains.”

For their part, the trading firms say they have unique trading strategies that give them an advantage. Some say they
use sophisticated risk management software that can, for example, interrupt trades after a series of losses to
prevent large losses in a single day. But they concede that losses can mushroom.

Still, the growth of trading here suggests someone is making money — and many trading houses say they are
generating huge trading volume. Mr. Chan at Lazer Trade, for instance, says his branch office, with about 20
employees, trades up to five million shares a day.

Some of the trading firms have run into trouble with United States and Canadian regulators over their business
practices. In 2002, the National Association of Securities Dealers — now known as the Financial Industry
Regulatory Authority — reached a settlement with a firm affiliated with Swift Trade and its president, Mr. Beck, for
engaging in a deceptive trading scheme involving fictitious trades.

And in 2009, Mr. Beck and another affiliate of Swift Trade paid $20,000 in fines to the Ontario Securities
Commission after the regulator accused the firm of making misrepresentations about a client. That client turned
out to be partly controlled by relatives of Mr. Beck and tied to about 1,100 international traders in 50 international
offices and 30 Canadian offices.

Swift Trade executives maintain that they comply with the law. Today, the firm does not operate in the United States
but buys and sells stocks through a trading affiliate that is registered with the Securities and Exchange
Commission.

Regardless, many Chinese day traders see this as an opportunity to quickly gain new riches — by buying and
selling stocks more than 100 times a day, usually after holding a stock for less than five minutes, and hoping for
even the tiniest uptick in prices.

Although many traders say they earn less than $200 a month, some brag about earning $10,000 a month and say
they prepared for the business by playing online games.

“Day trading is like a battlefield,” says Qu Zheng, 24, who has been trading for over two years and typically trades a
million shares a day at Lazer Trade’s office in Beijing. “It’s very challenging because you can feel the pulse of the
market.”



A Taste of Chicago.....in Shanghai?
by Michael Toma, CRM

While Shanghai prepares its finishing touches for World Expo 2010, there’s another big event coming to Pudong –
index futures trading. The China Financial Futures Exchange officially announced that stock index futures will
commence on April 16, adding yet another option for the Chinese trading community. The CFFEX released the
statement right after the China Securities Regulatory Commission, China’s equivalent to the SEC and CFTC,
giving official approval for trading. The contracts will be based on the CSI300 index. Contracts for May, June,
September and December will be the first to trade, with the May and June contracts requiring a 15% maintenance
margin. September and December contracts will require a slightly larger deposit of 18% margin. In addition, a 0.05
percent transaction fee will be levied on the total turnover according to the statement. It is the first time the China
trading community can profit from falling prices by 'shorting' the market index.

This implementation follows the January approval in principle to the launch of stock index futures and a margin-
trading pilot program in a move to further develop China's financial markets. Investors were permitted to begin the
application process for futures trading accounts in February.

Those willing to participate will be required to have a minimum 500,000 yuan, or $73,206 U.S. dollars to open an
account, which bars a majority of the average retail traders from participating. It’s quite a hefty admission ticket to
enter the park for Chinese trading standards. Investors must also have passed an examination on futures trading,
participated in simulated trading for at least 10 days and conducted at least 20 transactions. Clearly, the CSRC is
rolling out futures trading at first to limited participants with adequate capital and to the ever-growing hedge fund
communities. The concern of the smaller retail trader’s ability to handle and manage futures risk is still on the
minds of the regulators, and rightly so.

As trading nears commencement, China’s appetite for trading continues to accelerate. New stock account
openings were the highest in three months as households shifted funds into equities to protect against faster
inflation. The CSI300, China’s version of the Dow Jones, had reached an increase of + 91% from the recession
lows driven on the government programs to stimulate growth and has had an impact on the fury to invest.  The
index has retraced a bit since then due to continued government stimulus measures designed to contain inflation.
With bank deposit rates falling, the Chinese are considering better returns elsewhere. The introduction of stock
futures trading may also be attracting investors as an avenue to put their savings to work.

The jury still appears to be out regarding Chinese bank's involvement in the settlement of stock index futures but it
appears unlikely banks will participate in such settlement, at least for now. "Banks are not allowed to invest in
stock-index futures under the existing legal framework, but we are in talks with other regulators on allowing banks
to clear futures trade as special clearing members," the China Banking Regulatory Commission said. As special
clearing members, commercial banks could gain from such deals with their clients, usually futures companies,
but the regulator remains cautious on giving this the green light due to the unlimited risks that participating banks
will face. According to China’s futures trading rules, if banks are granted permission to conduct clearance for their
clients, they have to be prepared to assume the responsibility of refunding the huge debts that defaulting clients
incur. In summary, what better way to reduce risk than lifting or keeping the initially high margin requirements?

As if the Miracle Mile was transplanted right into the Pudong area, the China Financial Futures Exchange has also
announced they will introduce a mini-sized contracts for stock index futures in an attempt to rope in more retail
investors should the initial launch of stock index futures instrument go smoothly. In a statement by the general
manager of the CFFEX, Zhu Yuchen, said "We will gradually introduce mini-sized index futures to allow more small
and medium investors to trade after the new financial tool runs smoothly for some time."  There is also discussion
of the mini-sized contract being modeled on the ChiNext Index, commonly known in China as the ‘Gem Funds’.

China currently has limitations for foreigners to trade stocks on China-domestic exchanges. Many U.S. traders are
limited to ADR hybrids stocks on the NYSE or a limited number of big-beta stocks that trade on the Nasdaq, such
as Baidu or China Mobile. Chinese authorities however are making policies that would give overseas investors
access to China's stock index futures trading. Overseas investors would be able to engage in the stock index
futures trading under the status of Qualified Foreign Institutional Investors (QFII), said Zhu Yuchen. The exchange
is currently working on rules for QFII to trade index futures. Zhu said the QFIIs would be allowed to use a portion of
their investment quota towards futures trading. The actual limits are expected to be publicized soon, he said.  

The regulators recently raised the minimum trading margin for index futures from 10 percent to 12 percent and
reduced the single-day maximum holding of futures contracts to 100 from 600, which was previously set during the
trial period. Clearly, this is an attempt to play the conservative risk model at the onset of the futures program. "The
main functions of the revisions are to ensure the smooth launch of index futures, effectively control trading risks
and improve the risk-management mechanism," said a CFFEX spokesman. "We will further improve the rules
based on feedback we receive from the public," he said. The revised rules also seek to force investors to cut
holdings when futures' prices consecutively hit the daily trading limit, which is 10 percent above or below the
previous day's settlement price. Each index point is worth 300 yuan and the minimum trading unit is 0.2 point. This
is the equivalent of an S&P 500 e-mini futures contract worth $45 and the minimum tick worth $9.50. This model is
reflective of the $50 / $12.50 value standards currently in place for the U.S. based S&P 500 e-mini futures.


Market observers say the launch of index futures will have a limited impact on the stock market in the mid to long-
term, but the short-term impact remains to be seen. One must commend the CSRC and CFFEX for proceeding
with this program with caution since its initial announcement in 2006. Systems appear to be all ready but only time
will tell if the Chinese trading public has the savvy to employ proper risk management techniques with their new
trading toy on the block. As new futures accounts are opened at a time of a near doubling of stock prices, traders
will need to go beyond the application questionnaire and margin requirements in order to be successful. This will
apply to the hedge fund marketplace as well, which may have the systemic risk controls in place, but still may be
battling a liquidity and margin ceiling. On a recent trip to Shanghai, I spoke with many traders who not only did not
know how to short, but also felt uncomfortable with it and would prefer just to have everything ‘go up’. I’m hoping
Chicago based futures training can play a role in the educational learning curve required for the Chinese to be
successful in futures trading. Regardless, it is a long time coming for the westernization of Asia’s financial
markets. Deep-dish pizza is finally making its way to the streets of Shanghai.
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