China has long been a focal point for US derivatives exchanges that see its financial markets as the next growth frontier. After years of talks and friendly visits, US exchanges are closing significant business deals in China and beginning to tap into its enormous potential.
Virtually every Chicago and New York futures exchange has signed memorandums of understanding (MOUs) with Chinese exchanges, an often non-committal, ceremonial arrangement. But an MOU between Chicago Mercantile Exchange (CME) and China Foreign Exchange Trade System & National Interbank Funding Centre (CFETS) signed in 2004 blossomed into the first major deal between a US exchange and Chinese market in March. The agreement will allow Chinese financial institutions and investors to trade CME forex and Eurodollar contracts electronically. No start date has been announced but it is significant because CFETS, operated by the People’s Bank of China, is the only foreign exchange and interbank money market in China.
Valuable channel into China
The multi-year agreement provides CME with a valuable distribution channel into the Chinese market.
“We have been working with our colleagues in China over the past couple of years to help them in further developing their own financial market systems, including, eventually, their own derivative markets,” says Craig Donohue, CEO of CME. “So this is a bridge between our expertise and what we represent in global futures markets and China’s first entrée into providing access for Chinese banks and financial institutions to CME’s own foreign exchange and interest rate markets.”
More formal agreements and relationships may be coming with US exchanges. China announced in February that it is creating a new financial derivatives exchange that will be owned by China’s three futures exchanges and two stock markets. The as yet unnamed exchange, which is expected to be launched later this year, may provide further distribution deals.
Three-pronged approach
Meanwhile, Chicago Board of Trade (CBOT) is working on building on a 25-year plus relationship with China, a major force in its treasury and grain futures markets. Bernie Dan, president and CEO of CBOT, says the effort to stay connected with China involves a three-pronged approach of building relationships, educating Chinese exchange professionals and maintaining a dialogue with China’s regulators.
“You have to stay focused on China because you have a couple of different dimensions there,” says Mr Dan, who knows Asia from his stint as a former top executive for Cargill Investor Services in Singapore. “You have Chinese institutions that use our markets. You also have to monitor the deregulation that’s going on in China and the potential customers who may be able to participate in our financial products. And we have active soybean crush users in China who make active use of our markets today. So we’re active in that part of the world and have to continue to nurture it.”
With China as a major importer of South American soybeans and soybean meal, CBOT developed a South American soybean futures contract last year. The contract aims to create a customer base that includes Chinese importers, European buyers and South American sellers.
Untapped options market
Even US equity options exchanges have become more engaged with Chinese markets. Chicago Board Options Exchange (CBOE) signed MOUs with both Shanghai markets, Dalian and Shenzhen Stock Exchange, last spring. Richard DuFour, executive vice-president, corporate planning and development at CBOE, says the domestic exchanges have been pressing regulators to offer options. “These exchanges all want to trade options,” says Mr DuFour. “They also all recognise that the huge untapped market is in financial derivatives, which includes futures and options.”
One obstacle is that about 70% of China’s publicly traded companies are still state owned, which makes equity options or stock index futures and options difficult to develop. China is divesting from many of those companies but that may take months or years.
As slow as that seems, dealing with China in months or years is a timeframe that exchange executives are willing to work with. “They are the fastest growing economy and this is a revolution that is happening in China,” says Mr Donohue. “But they have to go step by step.”
