The imminent introduction of stock index futures and a mechanism for short selling will fundamentally change China's stock market, according to analysts.

 

The changes, they say, will create a regulated system able to generate liquidity from institutional as well as high-rolling investors.

 

"The launch of stock index futures will bring revolutionary change to the country's stock market and even the whole financial market," said Hu Ruyin, head of research at the Shanghai Stock Exchange (SSE).

 

"Short selling will fundamentally change what, in Chinese, we call the 'one-sided market' status quo and will allow stock investors to benefit not only from a rising market, but also from a falling market," said Hu.

 

Short selling the sale of borrowed securities in anticipation of a fall in price before delivery from which profits can be generated has not previously been allowed in China's 16-year-old stock market because of fears of rampant speculation.

 

Thus far, so-called "long" investors have only been able to benefit from price increases; however, the introduction of a short-sale mechanism will allow investors to profit from price falls as well as gains.

 

"For a long time, China's stock market has followed the simple pattern of being pushed up by long investors and then slumping when bubbles burst. Short selling will put an end to that," said Zhu Huacheng, a derivatives analyst with Xiangcai Securities Co.

 

In a separate development, according to unnamed officials quoted in China Securities News, stock index futures contracts are to be the first instrument introduced on Shanghai's proposed financial futures exchange.

 

The exchange is expected to open later this month, with trading in stock index futures opening in September.

 

SSE's Hu said the launch is likely to coincide with a comparative slump, a situation that will minimize the outflow of funds away from the regular stock market. In the long run, according to Hu and other analysts, fund outflows will not be an issue.

 

"In the short term, the launch of stock index futures might divert funds away from regular stocks. But from a long-term perspective, they will only boost stock trading and help rationalize price fluctuation, assisting the healthy development of the market," said Tan Xiangqiu, a derivatives analyst from Shenyin Wanguo Securities Co.

 

There has also been much speculation concerning contract details, brokering regulations and clearing methods.

 

Contracts are expected to be based on the existing Shanghai & Shenzhen 300 Index, which covers about 60 per cent of the market value of the Shanghai and Shenzhen markets.

 

"In the mid to long term, the launch of stock index futures will not affect the spot stock index, but in the short term the launch will have an impact," said Tan.

 

Officials have confirmed reports that futures brokerage companies are to take over the majority of the broking business for stock index futures contracts.

 

To become a full clearing member of the proposed futures exchange, a company must have a minimum registered capital of 100 million yuan (US$12.5 million).

 

To conduct broking for clients, securities firms need to either buy into a futures company or apply to become an introducing broker in partnership with a futures firm.

 

The introduction of stock index futures is expected to lead to the merging of securities firms and futures companies, said industry insiders.

 

"The introduction of index futures contracts will considerably increase mergers and acquisitions among securities firms and futures companies. Talks are now being held between securities firms and futures companies concerning acquisition and integration," said Dang Jian, president of the Shanghai CIFCO Futures Brokerage Co.

 

In the latest development, Shanghai-based Everbright Securities Co signed an agreement to acquire a controlling interest in Shanghai Nandu Futures Brokerage Co, the China Securities News reported yesterday, quoting unnamed Everbright officials.

 

The Everbright officials said that, if allowed by regulatory authorities, they would like to increase their holding in Nandu and eventually make the company wholly owned.

 

Most other securities firms identify with Everbright's strategy, as sharing a client base with a futures company that is not wholly owned is considered risky.

 

Stock market sources expect stock index futures trading to generate a turnover twice that of regular stocks potentially as much as 8 trillion yuan (US$1 trillion). Given that commission fees would be charged at 1/10,000th of the transaction value, trading could produce as much as 800 million yuan (US$100 million) for brokers.

 

The stock index futures market is initially likely to attract institutional investors such as mutual funds, social security funds, insurance companies and qualified foreign institutional investors, who would use the instrument for hedging and profit-making purposes.

 

Margin trading, which allows financial institutions to lend securities or money to investors, will enable short selling of shares by individual investors for profit, said analysts.

 

(China Daily August 3, 2006)