VZCZCXRO8866
RR RUEHCN RUEHGH
DE RUEHGH #0097/01 0790743
ZNR UUUUU ZZH
R 190743Z MAR 08
FM AMCONSUL SHANGHAI
TO RUEHC/SECSTATE WASHDC 6748
INFO RUEHBJ/AMEMBASSY BEIJING 1766
RUEATRS/DEPT OF TREASURY WASHINGTON DC
RUEHGZ/AMCONSUL GUANGZHOU 1129
RUEHSH/AMCONSUL SHENYANG 1156
RUEHCN/AMCONSUL CHENGDU 1158
RUEHHK/AMCONSUL HONG KONG 1290
RUEHIN/AIT TAIPEI 0968
RHEHAAA/NSC WASHINGTON DC
RUEHGH/AMCONSUL SHANGHAI 7287

UNCLAS SECTION 01 OF 02 SHANGHAI 000097 
 
SIPDIS 
 
SENSITIVE 
SIPDIS 
 
STATE PASS FEDERAL RESERVE BOARD FOR JOHNSON/SCHINDLER; SAN 
FRANCISCO FRB FOR CURRAN/GLICK/LUNG; NEW YORK FRB FOR CLARK/CRYSTAL/MOSELEY 
STATE PASS CFTC FOR OIA/GORLICK 
CEA FOR BLOCK 
USDOC FOR ITA/MAC DAS KASOFF, MELCHER AND OCEA/MCQUEEN 
TREASURY FOR AMB.HOLMER, WRIGHT AND TSMITH 
TREASURY FOR OASIA - DOHNER/HAARSAGER/CUSHMAN 
TREASURY FOR IMFP - SOBEL/MOGHTADER 
NSC FOR KURT TONG 
 
E.O. 12958: N/A 
TAGS: EFIN ECON PGOV CH
SUBJECT: CHINA FINANCIAL FUTURES EXCHANGE WAITING FOR STATE COUNCIL 
APPROVAL 
 
REF: 07 SHANGHAI 251 
 
(U) This cable is sensitive but unclassified and for official 
use only.  Not for distribution outside of USG channels. 
 
¶1. (SBU) Summary: In a March 5 meeting with Consulate TDY Econ 
Officer, China Financial Futures Exchange (CFFEX) Research and 
Development Head Dr. Zhang Xiaogang and his staff provided a 
status update on CFFEX preparations to launch a stock index 
future.  Licenses have been granted for 75 futures brokers and 
mock trading has been carried out for almost one and a half 
years.  CFFEX is awaiting State Council approval to launch the 
stock index future, after which time it will take one to two 
months to finalize regulations and commence trading.  Risk 
averse policy makers fear that stock index future trading could 
precipitate a stock market crash. 
 
-------------------------- 
Building Membership, Still Waiting for a Green Light 
-------------------------- 
 
¶2. (SBU) Though CFFEX was inaugurated on September 8, 2006 
(reftel), the exchange has yet to begin trading its first 
product, a stock index future based on the CSI 300. (Note: the 
CSI (China Securities Index) 300 represents 300 companies listed 
on China's Shanghai and Shenzhen Stock Exchanges, known as the 
Hushen 300 in Chinese.  Firms are included in the index based on 
a formula that includes total market capitalization and share 
tradability.  End note.)  CFFEX has been overseeing mock trading 
exercises since October of 2006, which include the participation 
of CFFEX's trading members. 
 
¶3.  (SBU) The membership of CFFEX has expanded to a total of 75 
across all the membership classes.  According to Dr. Zhang and 
as available on CFFEX's website (), there are 
12 Comprehensive Clearing Members (quanmian jiesuan huiyuan); 39 
Clearing Members (jiaoyi jiesuan huiyuan); and 24 Trading 
Members (jiaoyi huiyuan).  All of these CFFEX members are 
established as Futures Brokers and all are fully licensed. 
These brokers will trade for their clients, such as securities 
firms or regulator-approved insurance companies.  In the future 
commercial banks may be allowed as Special Clearing Members 
(teshu jiesuan huiyuan, of which there are none at the present 
time) and institutional investors, including securities firms, 
fund managers and QFIIs will be allowed as members, but specific 
regulations have not been drawn up yet for these classes of 
members. 
 
¶4.  (SBU) After building a substantial membership and carrying 
out many months of mock trading, CFFEX is waiting for a green 
light from the State Council to commence actual trading of the 
CSI 300 Index Futures.  Dr. Zhang noted that the launch is a 
political issue because by creating a means to hold short 
positions, some leaders are nervous that stock market volatility 
could increase dramatically and possibly lead to social 
disturbances.  Similarly, interlocutors at Chinese securities 
firms guessed that the index futures would not be launched until 
the new financial sector leadership was in place and that it was 
unlikely that a single individual would advocate the launch 
because of the possible negative market repercussions. 
Therefore, the go-ahead would come through a process of 
consensus building.  One securities firm manager in Shanghai 
thought it was unlikely that stock futures would be launched 
before the Beijing Olympics.  Once the futures are officially 
approved for launch, Dr. Zhang estimated it would take one to 
two months to finalize specific trading regulations and actually 
commence trading. 
 
--------------------- 
Managing Risk 
--------------------- 
 
¶5.  (SBU) CFFEX is aiming to limit the use of its instruments to 
hedging activities, rather than as tools for speculation.  As 
 
SHANGHAI 00000097  002 OF 002 
 
 
such, the exchange has initiated an investor education campaign 
for its members and has established a regulatory framework to 
pursue this goal.  CFFEX will take a "step-by-step" approach to 
its members that will entail a higher required margin on trades 
until a member's reputation is established.  Net short and long 
positions will be allowed, but outstanding positions will be 
limited to 600 contracts, which are RMB 1 million each. The 
large contract size itself is designed to deter speculators as 
well.  Institutional investors will be allowed to apply for 
higher limits on the level of contracts outstanding.  All trades 
will be subject to a pre-execution credit check, and margins 
will be collected on both sides of the trade, even if a firm 
holds both long and short positions. 
 
¶6.  (SBU) Oversight for financial futures trading will encompass 
the spectrum of regulatory agencies.  The Futures Supervision 
Department of the China Securities Regulatory Commission (CSRC) 
will oversee trading activities.  The CSRC established a 
third-party institution in 2006 to facilitate futures trades, 
the China Futures Margin Monitoring Center.  Each trading 
institution will be overseen by their respective regulators, for 
example, the China Banking Regulatory Commission (CBRC) will 
oversee commercial banks' trading activities. 
 
----------------- 
History Lends to a Cautious Approach 
----------------- 
 
¶7.  (SBU) When asked about China's previous experience 
introducing financial futures in the 1990s, which resulted in a 
bond market crash, Dr. Zhang and his staff drew contrasts with 
the present context for futures trading and the 1990s.  To begin 
with, in the previous decade the legal framework for futures 
trading was very weak, with no regulations to support trading 
activity.  The authorities have established and strengthened 
regulations, beginning with Futures Trading Regulations passed 
by the State Council in 1997.  The 1990s bond market crash is 
one reason that the current framework for futures trading leans 
more towards risk mitigation than efficiency.  Dr. Zhang's staff 
noted that the smooth and constructive performance of the 
commodities futures market has helped to lessen concern.  But 
risk averse authorities with an incomplete understanding of 
complicated financial derivatives err on the side of caution. 
 
------------------- 
Investors Eager for Stock Hedging Instruments 
------------------- 
 
¶8. (SBU) Dr. Zhang and his staff noted strong interest among 
institutional investors for stock hedging tools.  This sentiment 
was echoed by a director at a foreign-invested securities firm, 
who said that the firm's clients were very interested in the 
proposed index future. Currently investors can try to create 
proxy hedges with instruments in the Hong Kong and Singapore 
markets, but these offer imperfect coverage and limited 
liquidity.  Dr. Zhang thought that liquidity in China would be 
ample, given a demand for both long and short positions. 
 
¶9. (SBU) Dr. Zhang previewed traded financial derivatives that 
might follow the stock index future.  His team is currently 
researching exchange-traded stock index options and treasury 
bond futures.  They have done extensive research on these types 
of instruments in U.S. markets. 
JARRETT