Name: Guidelines on Trading of Stock Index Futures by Trust Companies (信托公司参与股指期货交易业务指引) (the “Guidelines”)
Issuing authority: China Banking Regulatory Commission (“CBRC”)
Effective date: 28 June 2011
Subject: Trust companies, stock index futures
The Guidelines took effect on 28 June 2011 and provide that a trust company may, with the approval of the CBRC and subject to certain restrictions, trade stock index futures (“Index Futures”) on the China Financial Futures Exchange (“CFFEX”) for the trusts managed by the trust company. This means that trust companies are a new category of institutional investors that is permitted to trade in Index Futures (along with securities companies, fund management companies and qualified foreign institutional investors). More importantly, the Guidelines expressly permit trust companies to engage in trading in Index Futures for arbitrage or speculative purposes under certain circumstances and therefore trust companies will have a wider business scope.
It will however be some time before trust companies are able to fully reap the opportunities afforded under the Guidelines for a number of reasons. First, until detailed qualification application procedures are put in place, trust companies will not be able to apply to the CBRC for approval to trade in Index Futures. Secondly, as the China Securities Regulatory Commission currently prohibits trust companies from opening new securities trading accounts, trust companies will not be able to conduct any hedge transactions on the CFFEX except for existing trusts with securities investments. Finally, as the CFFEX has yet to issue the relevant rules for financial institutions (including trust companies) to trade in Index Futures for speculative purposes, trust companies are currently unable to trade in Index Futures for speculation purposes.
Based on media reports, given the high risks involved in trading in Index Futures, the CBRC is likely to grant approvals to trust companies to trade in Index Futures in phases. The first batch of trust companies that are rumoured to be granted this approval include Shanghai International Trust, Shenzhen International Trust and Huabao Trust.
Highlights
Limits on trading activities
Where the trust scheme managed by a trust company is a collective trust product (i.e. there are 2 or more settlors), the trust company may trade in Index Futures for hedging and arbitrage purposes only. Where the trust product is a single trust (i.e. there is only one settlor), the trust company may additionally carry out speculative trading in Index Futures. Note that in the case of a trust formed by a bank entrusting to a trust company funds raised by the bank from its customers through the launch of a collective wealth management product, such a trust will be treated as a collective trust scheme (even though there is technically only one settlor, i.e. the bank), and accordingly cannot be used for trading in Index Futures for speculative purposes.
A trust company is not permitted to trade in Index Futures for its own account, nor is it permitted to trade in Index Futures for structured trust schemes (i.e. trust schemes which differentiate between junior and senior investors via varying levels of interests and risks).
Qualification requirements
A trust company must satisfy relatively strict qualification requirements as set out under the Guidelines, including:
(i) the applicant must have a regulatory rating of Grade 3C or above for the preceding year (in total, there are 6 grades from 1 to 6 with 1 being the best grade). Where trading is intended to be speculative trading, the rating requirement is increased to Grade 2C or above and the applicant must have traded in Index Futures for hedging or arbitrage purposes for at least one year;
(ii) the applicant must demonstrate that it possesses the necessary expertise to trade in Index Futures, including having an experienced trader, the relevant risk analysis and management personnel and personnel who are familiar with the relevant accounting procedures and system requirements. No individual may hold concurrent positions in these different areas;
(iii) the applicant must have a stable, reliable and efficient IT system to carry out the trading, valuation and risk control functions; and
(iv) the applicant must set up a Chinese wall between the hedging business and non-hedging business.
The stringent qualification requirements (particularly the requirement on the grade of regulatory rating) signals the CBRC’s intention to only permit trust companies with a good regulatory rating (typically companies that have sound risk management) to conduct innovative businesses and is also a sign of the CBRC’s intention to further sub-categorise trust companies into different tiers.
Risk control
Trust companies are required to closely monitor and control the risks associated with the trading of Index Futures. Detailed risk control requirements are provided under the Guidelines, including a requirement for the establishment of relevant internal control procedures which are to be approved by the boards of the trust company and various restrictions on the permitted level of exposure to risk.
Engagement of third party advisor allowed
The Guidelines permit a trust company to engage a third party as an investment adviser provided that the third party meets certain requirements (such as a minimum paid-in capital of RMB10 million). The trust company must set up a real-time monitoring and risk notification system, ensure that there is reliable communication with the advisor and retain the ability to adjust the positions during trading hours so as to meet the relevant risk exposure requirements.
If you would like to discuss anything regarding this Alert please contact Fang Jian (Shanghai/Beijing), Nicola Mayo (Shanghai), Simon Poh (Shanghai), or Betty Yap (Hong Kong).
