|Jeffrey Yang, from Reed Smith’s Shanghai office and a member of the firm’s energy and natural resources group, is due to speak at the upcoming In-House Congress Shanghai 2017. Below is a preview of Jeffrey’s speech.|
The medium sour crude oil contract, soon launching on the Shanghai International Energy Exchange (INE), will be the first Chinese commodity futures contract accessible to foreign investors. The principal driver behind the INE’s choice of crude oil as its first product is to allow China to develop its own benchmark for oil pricing while boosting trade in renminbi-denominated oil.
Physical settlement of crude oil futures contracts will be through the delivery of standard warrants representing crude oil, of the requisite grade, stored in bonded oil-storage facilities designated by the INE.
Although offshore access to futures markets for crude oil is not governed by the highest level of Chinese law, policies supporting offshore access to the futures markets were published in 2015, specifically targeting crude oil and iron ore, and have assisted in creating the necessary legal framework to enable offshore market participation. Among others, these policies provide for the VAT-free delivery of crude oil futures and provide the necessary conditions for access by overseas market participants.
For offshore participants, trading on the INE can be effected through four routes: (i) becoming an overseas special non-brokerage participant (OSNBP); (ii) becoming a client of an overseas special brokerage participant (OSBP); (iii) trading through an overseas intermediary; or (iv) becoming a client of a domestic futures firm member (FF Member). Offshore participants can only clear their positions through an FF Member.
A foreign client of an OSBP, FF Member or overseas intermediary must also meet certain trading-eligibility criteria. Each of the above routes has advantages and disadvantages, which will be discussed in Jeffrey’s speech. In excess of 95 domestic entities have already been approved as members of the INE and, along with offshore market participants, these entities are expected to provide much of the liquidity on the INE.
The INE follows the structure of other Chinese futures exchanges but, as with such exchanges, has features that may be unfamiliar to those who have not previously traded on domestic Chinese futures markets. For example, the INE acts as both an exchange and a clearing house; and in its capacity as a clearing house, acts as a central counterparty to the relevant INE member, whether acting as a seller or buyer.
The futures contract is settled in renminbi and the types of collateral accepted by the INE to support futures positions include cash, standard warrants, treasury bonds and any other acceptable collateral that the INE may announce from time to time. Such collateral may be denominated in renminbi or US dollars (or in any other currency that is subsequently accepted). Members must have sufficient funds in a clearing account held with banks approved by the INE as designated depository banks to meet their settlement obligations on the INE. The trading margin will need to be delivered on a daily basis to support marked-to-market exposures of the INE to the respective buying or selling INE member that it trades with in its capacity as a central counterparty.
The INE is presently applying to the Monetary Authority of Singapore for recognition as a ‘market operator’ and to the Hong Kong Monetary Authority as an ‘automated trading system’. In due course the INE will also seek similar approvals in the EU and US.
While the launch date for the INE’s crude oil contract has not yet been announced, it is widely expected to take place before the end of 2017. Depending on the success of the crude oil contract, the INE may herald the path for other exchanges and other futures products to become accessible from offshore.