Introduction

China has been the world's second largest economy, and the producer, consumer, trader of multiple commodities，but some of the commodities had high degree of foreign dependence. For performing the economic strategy, providing price discovery and risk management service on substantial economy and improving internationalization and pricing power of Chinese future market, China Securities Regulatory Commission (CSRC) made two important strategies. First, CSRC approved the establishment of Shanghai International Energy Exchange Corporation (“INE”) to carry out crude oil futures trading. Second, CSRC introduced overseas traders and brokers participating in China futures trading.

On 9 February 2018, CSRC spokesman announced at the press conference that after taking all factors into consideration, Crude Oil Futures will be listed and traded in INE which is the subsidiary of Shanghai Futures Exchange (“SHFE”) on 26 March 2018. This means the first international futures variety of crude oil futures will be listed, and it will explore the international market operation and regulatory experience of the futures market. It will also be the beginning of China’s futures market open-door to the outside world.

Ⅰ. Origin of China’s Crude Oil Futures

China Securities Regulatory Commission (CSRC) officially approved allowing the SHFE and Shanghai Futures Information Technology Co., Ltd. (SFIT) jointly as shareholders to establish Shanghai International Energy Exchange Corporation (“INE”) in Shanghai Pilot Free Trade Zone (SFTZ) on 28 August 2013. INE as the first Chinese trading exchange welcoming the investors from all over the world was subsequently incorporated in the SFTZ on 6 November 2013. Its main functions are to organize the specific futures trading, clearing and deliveries of crude oil and other energy derivatives(may include natural gas and petrochemical products in the future); formulate business management rules; implement self-discipline management; and publish market information. On 12 December 2014, CSRC approved INE’s proposal of carrying out crude oil futures trading. This is the first specific domestic futures category under which overseas investors are allowed to participate.

Subsequently, a series of rules have been formulated and issued. On 26 June 2015, CSRC officially issued Interim Measures on the Administration of Overseas Trading Participants’ and Overseas Brokerage Institutions’ Engagement in Trades of Domestic Specified Futures Products (“Interim Measure”), which provides legal basis for overseas special participants engaging in trades of domestic specified futures products. This Interim Measure will be enforced on 1 August 2015.

Currently, with regard to the standard contracts for crude oil futures and various trading rules which have been posted on the energy center’s website, it is only left to wait for the formal listing on 26 March 2018.

Ⅱ. Transaction Participation Patterns

Interim Measure expands the scope of participants in China’s futures market, permitting overseas traders and brokers engaging in specified domestic products trading, and provides various patterns for their participation, which breakthroughs the obstacle that overseas participants can not directly involved in China domestic futures products, and also paves the way for crude oil futures as the first product facing the global market. According to the Interim Measure, both overseas traders and brokers can involve in crude oil 

Methods of overseas traders participating in crude oil futures trades

There are the following three ways for the overseas traders participating in crude oil futures trades:

• Entrusting overseas futures brokers to participate in crude oil futures trades
• Entrusting domestic futures brokers to participate in crude oil futures trades
• Becoming a special member and directly participating in crude oil futures trades（generally is an institutional member）

As for “overseas trader that directly enters into the trading”，Article 5 of the Interim Measure also regulate it must satisfy the following criteria：

• its host country (or region) has a well-established legal and regulatory system;

• it has sound finances, good credit standing and sufficient liquid assets;

• it has a well-established governance structure, sound internal control system and proper business operations; and

• any other criteria stipulated by the futures exchanges.

Methods of overseas brokerage institutions participating in crude oil futures trades

There are the following ways for the overseas brokerage institutions participating in crude oil futures trades:

• Sub-entrusting domestic futures brokers to participate in crude oil futures trade

• Becoming a member of the exchange and directly participating in crude oil futures trade

• Establishing a wholly owned or joint venture futures market service institution in SFTZ to participate in crude oil futures trading

According to the Membership Management Rules of the Shanghai International Energy Exchange (“Membership Management Rules”) implemented on 11 May 2017, a qualified Overseas Intermediary shall meet the following criteria before a Futures Firm Member could provide the carrying-brokerage service to such qualified Overseas Intermediaries:

• being a financial institution legally incorporated and licensed for intermediary business by overseas competent authorities outside the Chinese Mainland and its business has been operated for at least two (2) years consecutively;

• being regulated and supervised by the competent futures regulatory authority in its residence country (region), which has signed a memorandum of understanding on supervisory cooperation with the CSRC;

• having a sound corporate governance structure and internal control system and duly operated business;

• having net capital of no less than RMB thirty (30) million or its equivalent in foreign currency;

• having business facilities and IT infrastructure conforming to the relevant technical standards and in sound operation; and

• any other requirements prescribed by the Exchange.

It is also required by the Membership Management Rules that a Futures Firm Member shall file with the Exchange after entering into the carrying-brokerage agreement with each Overseas Intermediary. Upon receiving all the completed filing materials, the Exchange shall, within fifteen (15) trading days, determine whether or not to accept the filing. The Exchange shall assign a filing number to the Futures Firm Member if the filing is accepted; or the Exchange shall give a written explanation if the filing is declined.

An Overseas Intermediary shall satisfy the conditions set forth in the Article 5 of the Interim Measure when becoming a member of the Exchange and directly engaging in the trading of crude oil futures, and the competent futures regulatory authority in its residence country (region) shall have signed a memorandum of understanding on supervisory cooperation with the CSRC.

Currently, the Administration Measures on Supervision of Futures Companies provides that the cumulative percentage of shares or interests held by foreign investor(s) in a futures company shall not exceed the commitments made by the China's futures industry for opening up of the futures industry. It is stipulated in the Notice of the General Office of the State Council on Promulgation of the Special Administrative Measures (Negative List) for Admission of Foreign Investments to Pilot Free Trade Zones (2017 Version) that the foreign investment ratio for futures companies shall not exceed 49%. The Interim Measure has not opened up the door. According to “Development Plan  for Further Promoting Pilot Financial Openness and Innovation in China (Shanghai) Pilot Free Trade Zone and Accelerating the Development of Shanghai International Financial Center” (“Promoting Program”) released on 30 October 2015，qualified foreign institutions are allowed to set up wholly-owned or joint venture futures market service institutions in the SFTZ and accept the entrustment by foreign traders to participate in the specified domestic futures trade.

It might be a good choice for overseas investors to set up a futures market service institution in the SFTZ to participate in futures trading. Firstly, overseas brokers establish a futures market service institution, which would be convenient for them to build up their brokerage business and developing China domestic market. Secondly, the established market service institutions are China’s legal entities, which may enjoy more benefits in terms of the market entry. Nevertheless, establishing a service institution in China will surely incur some operating cost. Overseas brokerage institutions shall assess and consider this based on its actual need.

Certainly, overseas traders and brokers should notice and follow special systems of the Chinese legal framework, such as investor eligibility system, transaction-coding system, margin depository system, information disclosure system, report system based on violation or dispute, and commitments of traders etc., which we will not describe deeply. Meanwhile, Interim Measure also regulated some requirements on overseas traders and brokers, who directly enter into market, like establishment of business management and risk management systems, etc.. 

Ⅲ. Foreign exchange settlement

On 31 June 2015, China State Administration of Foreign Exchange (SAFE) issued Circular of the State Administration of Foreign Exchange on Foreign Exchange Administration for Overseas Traders and Brokers Engaging in Futures Trading under Specific Domestic Categories (“Circular”), to regulate foreign exchange administration for overseas traders and brokers engaging in futures trading under specific domestic categories. The Circular will be enforced on 1 August 2015.

Circular stipulated that overseas traders and overseas brokers may remit funds inward in RMB or foreign exchange for futures trading under specific domestic categories. When providing services such as trading and settlement to overseas traders or overseas brokers for futures trading under specific domestic categories, a futures exchange may open a corresponding special foreign exchange settlement account with a futures margin depositary bank (“depositary bank”) for the receipts and payments, remittances and exchanges as well as transfer of funds involved in such trading. A depositary bank shall process the settlement and purchases of foreign exchange based on the actual results of futures trading under specific domestic categories by an overseas trader, an overseas broker or a member.

Circular further stipulated that the foreign exchange settlement and purchase only involves settlement of profit or loss from futures trading, payment of service fees, delivery of payment for goods, as well as call for payment of gaps in settlement currency, which are associated with futures trading under specific domestic categories. After foreign exchange settlement or purchases, the relevant funds shall be directly paid to the payee or transferred to the corresponding account in accordance with the institutional requirements on futures trading and settlement.

Conclusion

Along with the acceleration of opening-up in China, the futures market is developing rapidly and the need of internationalization is pressing. Promoting the opening-up of futures market is an essential part of completing China’s multi-level capital market system.

Launching crude oil futures is no doubt a significant investment opportunity for overseas participants and brokers. We trust more overseas institutions will be attracted and get involved in China’s futures market.

China has actively taken actions to establish an orderly and transparent future trading environment for overseas investors. However, issues including but not limited to settlement, risk control and dispute resolutions shall be prudentially designed and regulated. We expect the crude oil futures trade can be launched in late this year.