Financial Times: How Will Futures Market Serve Substantial Economy in Supply-side Reforms

Updated on: May 26, 2016

Reported by Gao Guohua, Journalist from Financial Times

Focusing on supply-side structural reforms and discussing issues of futures market serving substantial economy. The 13th Shanghai Derivatives Market Forum, sponsored by Shanghai Futures Exchange, was held in Shanghai on May 25. With the theme “Futures Market Serving Substantial Economy in Supply-Side Reforms”, the key contents such as the functions of futures market serving substantial economy in supply-side reforms, the structural adjustments of entity industries, and the innovation and development of derivatives markets were discussed in a profound manner. In addition, the views on the macro economic and financial situations at home and abroad in new normal conditions and hot issues of the development of futures and spot markets such as nonferrous metals, energy sources and over-the-counter derivatives were exchanged as well.

China is actively boosting its supply-side structural reforms to improve the supply efficiency and quality of supply systems and enhance new power for Chinese long-term stable economic development. Under the background of supply-side reforms, it corresponds with current economic development by discussing the functions and roles of futures market.

Giving full play to the resource allocation of futures market

As we all know, futures market plays a decisive role for resource allocation via prices. The prices include both spot prices and a series of future prices in time series. Spot prices mainly effect on current consumptions, while future prices command the productions and investments determining future supplies. The importance of future prices in resource allocation is no lower than that of spot prices.

According to Tu Guangshao, Executive Vice Mayor of Shanghai, as an arduous systematic project, supply-side structural reforms focus on five major tasks, namely cutting excessive productivity, inventories and deleveraging, lowering costs and improving weaknesses. The crux is deepening market-oriented reforms by following market rules and using market mechanism to solve problems. In addition, entity enterprises will face more risks during transformation and upgrading, and diversified risk management tools are required to resolve risks and deepen reforms.

In recent years, Chinese futures market has witnessed rapid development. The number of traded futures products has been increased to 46 from 23 in 2010, the beginning of the 12th Five-Year Plan. The 46 products can basically cover worldwide major bulk commodities. The futures market has shifted to qualitative changes from quantitative changes. An increasing number of enterprises have participated in futures market to conduct market-oriented pricing by using future price information, which has improved their operation efficiency; they have enhanced their risk resistance capacity by managing risks with the usage of futures tools. In addition, the function of futures market in serving substantial economy has been increasingly important. 　　

Tu Guangshao says, “At present, China is actively boosting its supply-side reforms. New requirements and opportunities have been made for the construction of futures market.” Developing Shanghai’s market of commodity futures, properly propelling opening to the outside world, forming more influential prices and expanding the supply of risk management tools can more effectively improve market-oriented pricing mechanism, eliminate outdated production capacity and adjust industrial structures so as to provide adequate protection for the transformation and upgrading of entity enterprises.

According to Fang Xinghai, Vice President of CSRC, next step the mechanism of selling market demand-oriented futures will be reformed and improved to list more relevant products and conduct effective supervision, including launching bulk commodity future and commodity options such as crude oil. In addition, two-way opening to the outside world will be improved to attract overseas investors and attract domestic enterprises and financial institutions to participate in the trading of commodity futures so as to establish an open, inclusive, competitive and cooperative futures market.

Providing protection and guarantees for the development of substantial economy

In accordance with relevant data, Chinese output, consumption and trade volume of nonferrous metals have been ranking No.1 worldwide for 14 consecutive years. With the expansion of commodity hedging and substantial increase of futures trading in the nonferrous metals industry, the international influence of Chinese futures market has been increased dramatically, making positive contributions for the pricing of nonferrous metals in international markets. More importantly, futures market has been an effective supplement for entity enterprises to realize buying and selling after many years of development. Enterprises may fully utilize futures market to achieve changes in terms of business patterns and operation modes.

Chen Quanxun, President of China Nonferrous Metals Industry Association, expressed in a speech that, entity industries and futures market are mutually dependent and stimulating. As a large country with nonferrous metals industry in the world, the gigantic industry scale and participation of numerous entity enterprises are the foundation for Shanghai Futures Exchange to develop and expand. Vice versa, the adequate utilization of Shanghai Futures Exchange’s futures functions can enhance the risk control ability of nonferrous metals entity enterprises, strengthen the function and status of Chinese nonferrous metals industry in the international pricing system, and effectively drive the structural adjustment, transformation and upgrading of the nonferrous metals industry.

“Because purchases and sales are based on future prices and we keep using futures market for hedging for more than two decades, Jiangxi Copper has been one of Fortune 500 enterprises from a small and medium-sized copper company. During its development, futures market and hedging have been playing an important role, and futures market has provided favorable protection and guarantees.” Wu Yuneng, Deputy General Manager of Jiangxi Copper says.  The high transparency, strong liquidity and concentrated market supply and demands of futures trading can accurately and comprehensively reflect actual supplies and demands as well as variation trends, making effective guidance for manufacturers. Based on hedging, relevant enterprises can transfer spot price fluctuation risks through futures market so as to get fixed prices of raw materials, inventories and products, which are quite important to guarantee profits under the background of sluggish business environment.

Practices show that enterprises can completely transfer market risks through hedging. In addition, the correlation coefficient of future prices and spot prices for nonferrous metals maintains above 0.9. The favorable price correlation of nickel futures has made it a pricing standard for its spot prices. 　

However, as another bulk commodity, the industries related to crude oil are not as lucky as nickels. Due to the absence of “authoritative” price signal guidance and risk management mechanism in such industries as well as incomplete market systems, the development of such industries cannot realize truly meaningful connections with global markets; such industries have to rely on “policy-based protection”, affecting the market competition awareness and ability of the enterprises in such industries. According to Cai Dongcheng, a professor at the School of Finance and Business of Shanghai Normal University, the supply-side reforms of the energy industry are important components of the structural reforms in the heavy chemical industry, while correct market guidance will be an important factor determining the success of such reforms. Authoritative “price signals” and product benchmark guides may become focuses for mutual adaptation between supply and demand, while the places and measures for avoiding operational risks are key factors for the sound development of relevant industries.

Driving enterprises to adapt to supply-side reforms with innovations

For the industry of bulk commodities, supply-side structural reforms are both challenges and good opportunities for transformation. According to Ma Wensheng, President of Xinhu Futures, the derivatives market can better utilize derivatives during the course to help enterprises realize economic transitions.

Ma Wensheng introduced that futures market shall further innovate its business mode and give full play to its role in helping enterprises during supply-side reforms and transformation. First of all, the innovation of pricing systems for bulk commodities. Enterprises shall integrate upstream and downstream industry chains and further optimize industry chain pricing systems during the process of utilizing futures market to make relevant bulk commodities adapt to downstream and upstream trade chains based on benchmark prices of futures. Secondly, the innovation of financing modes. “enterprises can use the futures market to manage the price, and use the third party warehouse to manage the spot goods, so the banks are willing to allocate funds to support enterprises needs for warehouse financing and order financing. For the security of capitals is guaranteed, banks can use such modes to support the development of enterprises.” Says Ma Wensheng. Lastly, the innovation of risk management tools. Besides futures market, there are new risk management tools, such as swap, over-the-counter options and mid and long-term contracts of bulk commodities in the market. These diversified tools can provide risk management services for enterprises.

Ma Wensheng says, “During supply-side structural reforms, futures companies can also satisfy enterprises’ needs by making independent explorations and innovative business.” Futures companies will mainly make innovations in terms of asset management, risk management and consultation services. For example, in terms of asset management, such companies may raise funds for the risk management of relevant enterprises by using asset management accounts so as to solve the issue of capital source for such enterprises and some issues of income distribution in hedging. Ma Wensheng added, “By making such innovations, futures companies can better serve entity enterprises via innovation businesses instead of being simple brokers.”