China index futures may tame asset bubbles, Macquarie says

Updated: 2010-04-16 10:42
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China's stock-index futures will allow investors to hedge risks from potential asset bubbles and make equities cheaper in the long-term, according to Macquarie Group Ltd, Australia's largest investment bank.

Futures trading, which starts today, is part of China's push to provide more investment options for investors and ease fluctuations after the Shanghai Composite Index slumped the most among major global markets this year following an 80 percent rally in 2009. It will be based on the CSI 300 Index, tracking the 300 biggest stocks on the Shanghai and Shenzhen bourses.

"It will help tame asset bubbles over time," Michael Kurtz, head of China research at Macquarie Group, said in an interview in Shanghai. "It will bring down the long-term PE average and hedge downside risks."

The Shanghai Composite Index trades at a historical price- to-earnings ratio of 35.7 times, compared with the current valuation of 28 times, according to weekly data compiled by Bloomberg. The Hang Seng China Enterprises Index, which comprises mainland companies trading in Hong Kong, trades at 17.9 times earnings.

The Shanghai index has fallen 3.4 percent in 2010, making it the worst performer in Asia, on concern the government will tighten monetary policy to slow record lending growth and soaring property prices. The government has twice this year required banks to set aside a larger proportion of deposits as reserves this year. The CSI 300 Index has fallen 5 percent this year after jumping 97 percent in 2009.

'One-way market'

"China had the biggest declines among the major markets in the past and there was nothing investors could do," said Guo Hongjun, director of the research institute at Shanghai-based Haitong Futures Co. "Stock-index futures allow investors to hedge their exposure and prevent the sort of one-way market in the past."

China's economic growth accelerated to the fastest pace in almost three years in the first quarter, highlighting overheating risks that may prompt the government to scrap the yuan's peg to the dollar.

Last year's rally in Chinese stocks and property prices prompted analysts including former Morgan Stanley economist Andy Xie to call the nation's asset markets a bubble that will burst once the government curbs credit. China is "on a treadmill to hell," with growth driven by the "heroin of property development," hedge fund manager James Chanos said last week.

The introduction of stock-futures trading may not attract that many investors initially because of the high minimum amounts need to open accounts, said Jeremiah Feng, a Shanghai- based fund manager at HSBC Jintrust Fund Management Co, which manages about $1.5 billion.

Many can't play

The futures contracts are agreements to buy or sell the CSI 300 Index at a preset value on an agreed date. Investors need a minimum 500,000 yuan to open an account to trade index futures, according to rules by the securities regulator and the China Financial Futures Exchange.

"About 80 percent of retail investors cannot meet the requirement," Feng said in an interview in Shanghai. "Many institutional investors, such as fund management firms, aren't allowed to play the market for the moment."

Investors must pay cash deposits equivalent to 15 percent of the contract value for May and June contracts and 18 percent for contracts for September and December. The contract values are points of the CSI 300 multiplied by 300 yuan and the minimum contract price movement is 0.2 point, according to the futures exchange.

"It's said only about three to five percent of the investor base is eligible to take part," Macquarie's Kurtz said.

The trading of index futures follows the introduction of margin trading and short selling on March 31. Shanghai, which has plans to develop into an international financial center by 2020, may start a board for listings by overseas companies later this year, the China Daily newspaper reported yesterday.

Rising liquidity

Trading will be at the "expensive side of fair value" as volumes will be limited initially, Goldman Sachs Group Inc said in a report yesterday.

"Under close monitoring by authorities, we expect a gradual increase in liquidity, but even then we do not expect a significant direct impact on the stock market," wrote Christopher Eoyang and Jason Lui, analysts at Goldman Sachs.

Trading volumes for China's local-currency A shares should increase with the introduction of stock index futures, Jing Ulrich, JPMorgan Chase & Co's chairwoman for China equities and commodities, said last month.

China has the world's third largest stock market by market capitalization, briefly overtaking Japan in July 2009. The US is the biggest by market cap.

US challenge

China's increased trading in equities from index futures will help the nation challenge the US as the world's busiest stock market, according to Guotai Junan Securities Co and HSBC Jintrust.

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"It's possible for China to surpass the US in terms of trading volumes, and index futures trading is one positive factor that's bolstering transactions," Liang Jing, a Shanghai- based analyst at Guotai, the nation's second-largest brokerage in terms of broking revenue, said last week.

China currently restricts overseas investors to buying B shares that trade in US dollars in Shanghai and Hong Kong dollars in Shenzhen. China's yuan-denominated A shares, are mostly limited to local investors.

Haitong's Guo said regulators may relax restrictions on index futures after a few months if trading is "stable".

"Chinese investors still hold a speculative mindset and it's likely we will see a surge at the start of trading," he said.