June 20, 2017 / 12:00 PM / 2 months ago

RPT-COLUMN-China's plan to boost commodity trading needs reality check: Russell

(Repeats item issued earlier. The opinions expressed here are those of the author, a columnist for Reuters.)

By Clyde Russell

LAUNCESTON, Australia, June 20 (Reuters) - The call by China's securities regulator for the country's wealth managers to invest in domestic commodity futures is both encouraging and somewhat bizarre.

The China Securities Regulatory Commission (CSRC) aims to promote the domestic derivatives industry by loosening regulations that restrict how commercial banks, insurance companies and pension funds invest in commodity futures, Fang Xinghai, the commission's vice chairman, said on June 17.

Fang, who was speaking at a financial forum in Qingdao, didn't give further details of the proposal, but it seems to fit into recent moves by the authorities in Beijing to promote commodity trading and become more of a player in global markets.

The positive news out of the CSRC's announcement is that China seems to be getting serious about opening up its markets and encouraging a broader range of participation.

Several commodity contracts have taken off in recent years, such as iron ore on the Dalian Commodity Exchange (DCE). But these have often been criticised as more like legal casinos for day-trading retail investors rather than offering price discovery or viable hedging for market participants.

As part of efforts to boost commodity trading, China's three major exchanges, the Shanghai Futures Exchange, the Zhengzhou Commodity Exchange and the DCE, are planning to boost the number of commodities that can be traded.

Contracts for certain fruits, chemicals and electricity are among those being considered, adding to an already considerable array of contracts for commodities that would be considered somewhat obscure in Western markets, such as bitumen and silicomanganese.

But while expanding the amount of commodities being offered and boosting the number and type of investors allowed to participate in the markets sounds promising, it's not straightforward.

TRUST DEFICIT

If there is one thing investors have learnt about the authorities in Beijing is that they aren't afraid to intervene in what are supposed to be free markets if they don't like the price movements and volatility.

On several occasions last year, the authorities took steps to crack down on trading in then hot commodities such as iron ore, steel and coal.

Measures included increasing margins to be held against positions and boosting the cost of trading on the exchanges.

These steps did have some impact on cooling commodity trading last year, but probably not to the extent that the authorities wanted.

The problem for investors in Chinese commodity exchanges is that they can never be certain as to when, and how, the authorities will act to clamp down on trading.

Allowing financial institutions to trade in commodities may smooth out some of the volatility, assuming they adopt longer-term positions based on expectations of supply and demand fundamentals.

But if these investors choose to act more like hedge funds in taking large positions in order to drive the market in their preferred direction, it will boost volatility and undermine the use of Chinese commodity exchanges as a hedging tool.

As the world's biggest producer, consumer and importer of commodities, China should have well-developed and open futures exchanges.

But simply loosening regulations to allow for greater participation doesn't address the underlying problem in China, namely the uncertainty of government interference and the trust deficit this causes.

To be truly effective, China's commodity contracts would also have to be fully open to foreign traders, something that isn't currently the case.

But for foreigners to participate, regulatory certainty becomes essential, meaning Beijing must curb its inclination to intervene in the markets if it sees developments it doesn't like.

It's this problem that has so far prevented China from setting up a crude oil futures contract, which would be aimed at capturing a chunk of the global trade in this key commodity.

The struggles of China, the world's biggest importer of crude oil, to launch a viable futures contract covering the fuel shows just how far the country still has to travel in its ambition to become a global commodity hub. (Editing by Richard Pullin)

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