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 Q&A with Shanghai International Energy Exchange on rules and regulation pertaining to the proposed crude oil futures

After the release of 11 rules and regulations, the contract listing is believed to be going even nearer. As the first domestic contract that involves foreign investors, what innovations have been made by Shanghai International Energy Exchange (hereinafter referred to as INE) in contract and regulations design? How is the preparation work going? The INE has made its answer in every detail. 

Futures Daily:What is the significance of building up a Chinese crude oil futures market?
INE:The aim of building up a Chinese crude oil futures market is to provide enterprises with   effective price risks management tools and also risk preventions for their on-going operations.
Moreover, despite of the well-developed crude oil futures markets in Europe and US, theirs prices cannot fully give an objective reflection of supply-demand relationship in Asia Pacific. To launch Chinese own crude oil futures will help formulate a benchmark price system that reflects the supply-demand relationship of crude oil in China and Asia Pacific Region. Also, we can optimize the resources allocation in the market-driven approach so as to better serve the real economy. To build up a crude oil futures market is one of the most important practices that we carry out to promote opening-up and internationalization in Chinese futures market.

Futures Daily:What is the general thinking of the contract design?
INE: Our general thinking is “international platform, net trading, bonded delivery and RMB denomination”. International platform means the internationalization of trading, delivery and clearing, which gives domestic and foreign investors a free, efficient and easy access to the local market. With the support of spot crude oil market, INE will introduce domestic and international investors including multinational oil companies, oil traders and investment banks to trade in this market. So that they can better build up a benchmark price that reflects the supply-demand relationship in China and the Asia Pacific Region.Net price trading means the trading price doesn’t include any duty or VAT, which is different from the other local future prices and makes it easier to be compared with other international prices net of any taxes and also by doing so, we can avoid any influences brought by tax policy changes on the trading price. Bonded delivery means physical delivery shall be carried out based on bonded oil storage facilities because the price of bonded spot trade is also a net price free of any tax, and there’re fewer limitations on each parties of a bonded trade. Also, bonded oil storage facilities can function as a hub to connect both domestic and international oil markets, facilitating crude oil spot and futures traders to get engaged in trading and delivery. RMB denomination means RMB shall be used in trading and delivery, while USD and other foreign exchanges can be used as trading margin.

Futures Daily: How can domestic and global investors be involved in the crude oil trading?
INE: The trading mode will be exactly the same with the present one of Shanghai Futures Exchange for local traders and futures firms. Whereas there shall be 4 modes for global investors to participate in the trading of the first international contract in China’s futures market. One, to become an Overseas Special Non-Brokerage Participant (OSNBP) and trade directly on INE; Two, to become a client of an Overseas Special Brokerage Participant (OSBP); Three, to become a client of a local futures firm member (FF Member); and Four, to trade through an oversea intermediary, who will entrust its clients to local futures firm members or OSBP. The above-mentioned OSNBP and OSBP shall conduct their clearing with the INE through local futures firm members. In practice, overseas intermediaries are allowed to introduce overseas investors to local futures firm members and then trade as their clients.

Futures Daily: Why do you choose medium sour crude oil as the underlying product?
INE: There are a few reasons. Firstly, the resource of medium sour crude oil is quite rich, the production of which accounts for around 44% of the total amount in the world. Secondly, the supply-demand relationship of medium sour crude oil is not exactly the same as that of the light sweet crude oil and still there is no influential benchmark price for the medium sour crude oil in the global market. Thirdly, it is the major product imported by China and many other neighboring countries. According to General Administration of Customs’ statistics, in the year of 2016, China imported 381 million tons of crude oil, among which, 183 million tons came from Middle East, up to 49% of the total. So it will help further promote the international crude oil trade if we can formulate a benchmark price for medium sour crude oil.

Futures Daily: To facilitate the launch of crude oil futures, what supporting policies have been offered by national ministries and commissions?
INE: The crude oil futures has received great support from many authorities of the State Council, including Ministry of Finance, State Administration of Taxation, CSRC, PBoC, SAFE, and General Administration of Customs. A series of supporting policies have been made, including:
In April of 2015, the Ministry of Finance and State Administration of Taxation announced Notice of the Ministry of Finance and the State Administration of Taxation on Value-Added Tax Policies for the Bonded Futures Delivery Services for Crude Oil and Iron Ores, making it clear that bonded delivery of crude oil futures will be VAT- free at this point. In June of 2015, CSRC promulgated Provisional Measures on the Administration of Foreign Traders and Overseas Brokers Engaging in Specific Categories of Futures Trading, making regulations on their account opening, clearing, margin requirement and deposit. In July of 2015, PBoC released Announcement on Matters concerning Effectively Administering the Cross-Border Settlement of Domestic Crude Oil Futures Transactions, clarifying the regulations on currency used for trading and clearing, RMB account opening and its usage, ways of interest bearing, administration on special account, anti-money laundering and anti-terrorism financing etc. Also in July 2015, SAFE promulgated Notice of the State Administration of Foreign Exchange on Issues concerning Foreign Exchange Administration of Trading in Futures of Specific Categories in China by Foreign Traders and Foreign Brokerage Agencies, making clear the regulations on account opening and usage of relevant foreign exchange account, settlement, ways of interest bearing, administration on special account, reporting of international money transfers etc. In August 2015, General Administration of Customs released the Announcement on the Bonded Futures Delivery of Crude Oil, to support the bonded delivery for crude oil futures.

All these policies have provided the INE crude oil contract with a more robust base, so that INE can offer a more convenient and more internationalized trading approach to domestic and global investors and provide more convenience for the those participants.

Futures Daily: How do you regulate on the role of INE as a central clearing counterparty?
INE: As a central clearing counterparty, INE interposes itself between the buyer and seller when each transaction is done, acting as buyer to every seller and seller to every buyer, making settlement in the amount of net value and providing centralized performance bond to all the transactions. Meanwhile , it’s been explicitly stipulated in the General Exchange Rules that, “the legal attributes of property rights or derived from activities such as trading, clearing and delivery of executed orders, positions closed, cash received as margin, assets either pledged or transferred as margin collateral, standard warrants paired for delivery, or those actions adopted by the Exchange against any default event, shall not be revoked or considered null and void due to the commence of bankruptcy proceedings against any Member”. And, “in the event that a Member enters into a bankruptcy proceeding, the Exchange may still conduct net settlement for such Member’s holding positions in accordance with the General Exchange Rules and the related implementing rules thereof.”

Futures Daily: Compared to the opinion-soliciting version released earlier, what major amendments have been made in the final version?
INE: After soliciting opinion on the General Exchange Rules and all the other regulations, INE carefully deliberated on the feedback and thoroughly communicated with the regulators, before we made amendments on the contract specifications, threshold setting for eligible investors and ways of settlement for a delivery default event:
On contract design, the contract size is 1000 barrels per lot, largely in line with the mainstream international crude oil futures contracts. 
On investor eligibility, the threshold is set at RMB 500,000 for individual investors and 1 million yuan for institutional investors. Meanwhile, relevant trading experience and risk tolerance shall be taken into account. 
On the settlement of delivery default, penalty will be used, replacing “deferred delivery” in the earlier version.

Futures Daily: How do you set the minimum requirement of account balance of the clients?
INE: When an Account Opening Institution applies to a client, the INE’s criteria on account balance shall be met. According to the INE Futures Trading Participant Eligibility Management Rules, an institutional investor shall have a balance of no less than RMB 1 million (¥1,000,000.00) or its equivalent in foreign currency in each of its margin accounts five (5) business days before applying for the trading code. In the case of individual client, he or she shall have a balance of no less than RMB 500, 000 or its equivalent in foreign currency five (5) business days before applying for the trading code. Meanwhile, both institutional and individual clients shall possess relevant knowledge, pass relevant tests and meet the criteria on trading experience. 

As for how much money is needed for trading just one contract, INE explains that, required trading margin for one contract will be calculated based on the trading unit, contract price and trading margin. Traders shall make rational investment according to their risk tolerance ability and judgment for various market risks. If calculated according to the current oil price in the international market, one INE crude oil futures contract is worth around 350,000 yuan. If 5% trading margin is required by the Exchange while 7% required by the futures firm, investors who meet the account opening criteria will need 24,000 yuan in place as trading margin, when they trade one INE crude oil futures contract.

Apart from the threshold set for investor’s minimum account balance, INE also requires on minimum clearing deposit for its members. Minimum level for a futures firm member is set at 2 million yuan, while 500,000 yuan is required for a non-futures firm member. Meanwhile, in order to enhance risk tolerances of member firms, when undertaking authorization from oversea intermediaries, the minimum level of clearing deposit will be raised in accordance with the number of overseas intermediaries it carries. If one futures company gets engaged in the trading of crude oil futures on behalf of a domestic investor, the minimum clearing deposit balance will be 2 million yuan. However, if it at the same time clears for one OSP, the minimum level shall be raised to 4 million yuan. The rest can be done in the same manner.

Futures Daily: As the first internationalized futures contract, how do you strengthen risk management rules on it?
INE: On risk control, we will strictly adhere to methods that have been proven effective in the market, including margin requirement, one client one code, position limit, large position reporting etc. Meanwhile, in consideration of the risk profile of global investors and the characteristics of crude oil trading, we will proactively check on global investors’ eligibility, the usage of real name in account opening and reporting of actually control relations among different accounts. We will put emphasis on special account management and segregated accounts, promote coordinated cross-border regulation of various forms with overseas regulations, and explore on how to establish a pragmatic way of carrying out coordinated cross-border regulation and case inspection.

Futures Daily: As for the preparation work, what have been done and what are you going to do in the future?
INE: Approved by the China Securities Regulatory Commission, INE is fully funded by the Shanghai Futures Exchange and was registered in the China (Shanghai) Pilot Free Trade Zone in November, 2013. 

In the principles of internationalization, market-orientation, institutionalization and specialization, the INE, since its establishment, has been striving to establish a global trade network and an open, fair and impartial, efficient and secured trading platform for market participants both at home and abroad, attracting extensive participation of oil companies, financial institutions and investors from all over the world. Under the framework of “international platform, net price trading, bonded delivery and RMB denomination”, the INE has worked out the fundamental proposal of crude oil futures, has conducted in-depth research into and come up with optimized solutions of the contract design, deliverable grades, risk control in trading, settlement and delivery, the way how foreign investors can get involved, and has formulated the rules and regulations responding to the market needs. 

In the next phase, the INE will carry out further preparation work according its business rules and regulations, including verifying qualifications of member, Foreign Special Participants and certifying banks, designated storage facilities and designated inspection agencies, as well as carrying out a mock trading across the markets. The INE will try every best to list the contract within this year, with all preparation work done in a proactive and prudent manner.

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