China's Futures May Have A Future After All

After a crackdown, some of the exchanges are coming to life

Qiao Gang, chairman of the Beijing Commodity Exchange Ltd., is used to encountering people skeptical of his work. The first Chinese member of the Futures Industry Assn., Qiao traveled this spring to the U.S.-based group's convention in Boca Raton, Fla., declaring to bemused Westerners that Chinese futures are arriving on the world stage despite a series of setbacks and scandals. "The market is growing very fast," Qiao says.

Indeed, perhaps too fast. As in other industries, China is aspiring to join a global business before it works out the laws and regulations needed to inspire confidence. In commodities, trading technology has sprinted ahead, but manipulation has disrupted markets and shaken investors. That has led the government to ban a host of active contracts and shutter two dozen upstart exchanges. Beijing wants to encourage futures trading, believing that hedging and risk management can help the economy. But the government is uneasy about widespread speculation in the markets and unwilling to let prices of key commodities float.

Still, the news isn't all bad. Several of the 15 remaining exchanges have strengthened their risk controls and introduced technology that outpaces many Western exchanges. Moreover, the government is easing some restrictions. It recently issued an edict encouraging state enterprises to hedge in the futures markets. Chinese regulators have also approved futures trading in nine commodities such as rubber, corn, and plywood, and they have allowed limited, experimental trading in 27 other commodities, including rice.

Beijing's watchdogs have made it clear they will not allow the exchanges to grow beyond their control. The biggest regulatory action to date came when the government shut down the trading of bonds--China's only financial future--after a Barings PLC-style blowup last year in Shanghai. The government also banned futures on gasoline, sugar, and other key commodities when high prices threatened to spark inflation.

As the government feels its way along, the exchanges have managed to survive by embracing technology. From Beijing and Shanghai to Shenzhen and Hainan Island, markets are electronic. Computer-equipped traders can dial in via satellite from anywhere in China, opening the markets to all comers. "I don't need to be the Premier's cousin to jump in," says Paul Shang, senior director of Asian development at the Chicago Mercantile Exchange, who has provided assistance to the Chinese exchanges.

STEEP LOSSES. Yet many others doubt that China's freewheeling markets can fulfill key functions. In the rush to launch new exchanges, ordinary citizens suffered steep losses trading in many unlikely commodities--from watermelons to cigarettes. Even better capitalized futures exchanges have had trouble enforcing rules. Traders have manipulated prices and walked away from losing transactions. Now, the exchanges are introducing better risk controls. Qiao's Beijing exchange requires investors to post margins, or good-faith deposits, before a trade can be consummated.

Additional government interference remains the biggest threat to Chinese futures--and it worries outsiders. So far, multinationals operating in China have steered clear of the exchanges, believing that the government will put central control ahead of market integrity. "I don't think they're anywhere near letting the market work on its own volition," notes Cargill Inc. Chief Executive Ernest S. Micek. Another barrier: Many outsiders rule out investing until China's currency, the renminbi, becomes fully convertible.

Despite official denials, some outsiders say that Beijing will eventually open the market to foreigners. "They'll have to allow foreign participation before too long," says a Hong Kong-based analyst. "They need the liquidity." If that happens, Qiao Gang won't have as much trouble getting people to take his exchange seriously.

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