Caixin View: Exclusive Briefing on China’s Economy and Finance

Focus: Chinese Oil Futures Looking Slick

China finally began yuan-denominated crude oil futures trading in Shanghai on Monday in an effort to play a more influential role in setting global crude oil prices. The contracts, which trade on the Shanghai International Energy Exchange (INE), are the first commodity derivatives open to foreign investors who do not have a presence on the mainland.

Trading got off to a positive start on Monday with the most active contract, for September delivery, rising to as high as 447.1 yuan per barrel from the opening reference point of 416 yuan before closing up 3.34% at 429.9 yuan. Almost 40.7 million barrels of oil, or 40,000 contracts, changed hands through the contract during the five hours of daytime trading and about 18.3 billion yuan of contracts were traded, according to data from the Shanghai Futures Exchange, which double counts trading volumes and contracts. At Friday's close, the contract for September delivery was trading at 420.3 yuan per barrel and 58.8 million barrels of oil, or 58,800 contracts, changed hands.

In comparison, the average daily trading of the front-month contract (the contract expiring the soonest) for Brent crude traded in London was around 285,000 in March, more than 10 times the average number of contracts traded daily in Shanghai, when adjusted for double counting.

China is the world's second-biggest consumer and biggest importer of crude oil, and that has prompted authorities to try to gain more control over the pricing of the commodity. Global oil trading is currently dominated by two benchmarks — West Texas Intermediate, traded in New York City; and Brent crude, which trades on the ICE Futures Europe exchange in London.

But China, and Asia, rely mainly on oil from the Middle East which has no authoritative benchmark. The yuan-denominated oil futures contract launched in Shanghai is based on Middle Eastern grades known as medium sour crude oil with the aim of creating a benchmark that reflects supply and demand in Asia. The futures contracts should help Chinese companies lower their costs and hedge more effectively.

Barriers to entry to trade oil futures in Shanghai are relatively low – for individual investors only need a minimum of 500,000 yuan to trade and institutions only need 1 million yuan. But the big three state-owned oil companies are likely to dominate the market for some time, given their deep pockets and dominance of the spot oil market.

The government has made great efforts to attract international investors, however, in order to boost the importance and growth of the Shanghai futures market and turn the INE crude contracts into a benchmark for medium sour crude oil. Overseas investors will be grant income tax exemptions and brokerage firms won’t have to pay income tax on commissions earned on dealing in the new futures contracts. Margin requirements, financial guarantees to ensure traders can fulfill their contract obligations, can be paid in foreign currency.

However, foreign investors will still have to use the yuan to trade and this may make them more cautious about building exposure to the market because of controls on cross-border capital flows and on their ability to freely convert the yuan into other currencies. So although foreign traders and investors are being allowed into the market, it is local players who are expected to be the most active and to provide most of the liquidity.

In the short-term, the goal of launching yuan-denominated oil futures in Shanghai is to give domestic companies better risk management tools and help them get a better price for their crude oil. That's partly why the government has put in place measures to discourage speculation, including relatively high margin requirements compared with other markets, and higher storage costs for delivery of the crude oil.

The government does have other objectives establishing a benchmark for Middle Eastern oil – Chinese companies and making the yuan a more internationally traded and accepted currency. But these are much more long term.

Focus: Return of the Unicorns

China could unveil rules in the next one to two months that will pave the way for overseas-listed Chinese tech giants such as Alibaba and Baidu to make secondary offerings on the domestic bourses, Caixin has learned.

Dozens of home-grown technology companies have listed overseas in the past few years to sidestep the legal and technical barriers to IPOs on the mainland and to gain access to international investors and bond markets.

The policy, which has been endorsed by Chinese leaders including Premier Li Keqiang as part of a drive to upgrade the economy and move up the global value chain, will see the China Securities Regulatory Commission (CSRC) offer these companies a way to have their shares traded in China via securities known as China Depositary Receipts (CDRs).

Depositary receipts, which were created in the 1920s in the U.S., involve companies depositing stocks from their primary market listing with a bank, which will then issue securitized receipts of these stocks in a second market.

The CSRC could announce guidelines for issuing CDRs in the next one to two months, Caixin learned this week.

Alibaba and JD.com are expected to be the first companies to make secondary listings on the mainland. Baidu, Tencent, Ctrip.com International, Weibo, Netease Inc. and Sunny Optical Technology Co. are also potential candidates. Smartphone maker Xiaomi, planning to go public in Hong Kong this year, has agreed to list some of its shares on the mainland through CDR issuance. Hong Kong-listed wireless carrier China Telecom and personal computer maker Lenovo are also considering secondary listings, company executives have said.

A report by the Ministry of Science and Technology identified more than 160 unicorns in China and the government is keen to keep them close to domestic capital markets. CDRs will form part of the solution. But to stage proper IPOs on the mainland, companies will have to wait for policymakers to overhaul public listing regulations because current rules include onerous profitability requirements and do not allow dual-class shares.

At the end of 2017, nearly 500 companies were waiting for the CSRC to review their IPO applications. Regulators have signaled they are trying to expedite the process for tech companies, but altering listing requirements would take a long time as it requires changes to the country’s Corporate Law and Securities Law, according to an investment bank executive.

Domestic listings for large technology companies could suck up a large portion of the liquidity in China’s capital market. The eight most likely candidates listed above have a combined market capitalization of around 8 trillion yuan ($1.27 trillion). If just 5% of their shares were turned into CDRs, that would amount to 400 billion yuan, equivalent to 10% of the funds Chinese fund management companies have available for securities investment.

CDRs will likely track the prices of the shares in their primary markets, a pattern we have already observed for the American Depositary Receipts (ADR) of Tencent Holdings, listed in Hong Kong.

Weekly roundup

● North Korean leader Kim Jong Un paid a secretive three-day visit to Beijing, saying he was committed to denuclearization of the peninsula. It was Kim’s first foreign trip since taking power. North and South Korean leaders have since set a date for their first peace talks since 2007.

● Former chairman of freewheeling financial giant Anbang Insurance Group Wu Xiaohui admitted his guilt in fundraising over $100 billion through illicit insurance sales.

● Guo Shuqing, head of newly merged banking-insurance watchdog (CBIRC), was also named party secretary of the central bank (PBOC), as the government seeks to smooth inter-agency cooperation.

● Terry Branstad, U.S. ambassador to China, said on Tuesday that tariffs were threatened to spur China fulfill its promises and open its markets.

● Top policymakers approved sweeping rules putting the country’s $15 trillion asset-management industry under stricter scrutiny, to rein in risk and curtail the booming shadow banking sector. Details such as the length of a grace period for institutions to meet the new regulations are expected to be announced soon.

● Li Keqiang announced value-added tax (VAT) rates will be lowered as part of an over 400 billion yuan ($63.53 billion) tax cut package this year.

● The second-largest U.S. IPO this year faltered as Chinese video-streaming site Iqiyi shares dropped sharply on their first day of trading.

Upcoming events calendar

● March 31: NBS manufacturing PMI for March

● April 2: Caixin China General Manufacturing PMI for March

● April 4: Caixin China General Services Business Activity Index for March

● April 5-7: Qingming public holiday in China, stock markets closed on April 5 and 6

● April 7: China March foreign-exchange reserves data released by State Administration of Foreign Exchange

And finally, here are some of the key figures running China’s financial regulatory system, giving a send-off to Liu He, President Xi Jinping's top economic adviser. Liu had just visited the new China Banking and Insurance Regulatory Commission, in one of his first public appearances as vice premier. See Caixin's take on Liu's appointment here.