Following the promulgation of the Futures and Derivatives Law of the People’s Republic of China (the “Futures Law”), the China Securities Regulatory Commission (“CSRC”) has focused on the implementation rules of the Futures Law. This includes the Interim Provisions on Position Management for the Futures Market (the “Interim Provisions”), which was recently released by the CSRC on July 31. The Interim Provisions apply to both domestic and foreign futures brokers and traders participating in China’s financial and commodity futures markets. It tackles the absence of departmental rules on position management and provides a basis for futures exchanges to refine their relevant business rules. Futures exchanges shall carry out self-disciplinary management on futures position holdings in accordance with the Interim Provisions and their business rules and are authorized to specify the corresponding self-disciplinary measures for any violations in their business rules.
The Interim Provisions provide for position limits and exemptions, hedging, reporting of large positions, and position aggregation, which are summarized as follows:
1. Position Limits and Exemptions
Futures exchanges are authorized to determine and adjust position limits from time to time and may formulate special position limit management rules for arbitrage trading and market making. Trading participants are eligible to apply for exemptions from position limits for their hedging or other futures trading activities which are conducted for risk management purposes, as deemed by futures exchanges. The Interim Provisions stipulate that trading participants shall not evade position limits by improper means. Any violation of the position limit management rules by a trading participant may lead to self-disciplinary measures adopted by the futures exchanges against the trading participant or even administrative liability if the trading participant is deemed to have committed market manipulation. The administrative liability includes (a) an order for rectification; (b) the confiscation of illegal gains and a fine of up to 10 times the amount of the illegal gains; if there are no illegal gains or the amount of the illegal gain is less than 1 million yuan, a fine ranging from 1 million yuan to 10 million yuan may be imposed; and (c) if an entity commits market manipulation, the person directly in charge and other directly responsible persons shall be given a warning and a fine ranging from 500,000 yuan to 5 million yuan.
The definition of “hedging” given in the Interim Provisions is consistent with the Futures Law, i.e., “futures hedging” refers to futures trading, which the trading participants enter for the purpose of managing the risks arising from changes in the value of their assets and liabilities, that are basically comparable to the foregoing assets and liabilities. For futures hedging, trading participants may apply for an exemption of position limits and obtain relevant hedging quotas in accordance with the qualification requirements and application procedures formulated by futures exchanges.
According to the Interim Provisions, hedging quotas shall match the scale of a trading participant’s risk management activities and the risk tolerance of futures markets. Specifically, (1) the underlying products of futures hedging shall be the same as or closely related to the assets and liabilities with respect to spot goods; (2) hedging positions shall be used to manage risks arising from changes in the value of the assets and liabilities, or risks that have a significant impact on the changes in the value of the assets and liabilities; and (3) the opening, adjustment, and settlement of hedging positions shall be closely related to and coincide with business activities related to the assets and liabilities, such as production, trade, consumption, and investment; and the hedging position holding period shall be consistent with the duration of the risks of change in the value of the assets and liabilities.
The Interim Provisions stipulate that trading participants shall not obtain hedging quotas by fraudulent means, nor shall they abuse hedging quotas. For any violation of the foregoing provisions that are deemed as constituting market manipulation, the legal consequences may include (a) an order for rectification; (b) the confiscation of illegal gains and a fine of up to ten times the amount of illegal gains; if there are no illegal gains or the amount of illegal gain is less than 1 million yuan, a fine ranging from 1 million yuan to 10 million yuan may be imposed; and (c) if an entity commits market manipulation, the person directly in charge and other directly responsible persons shall be given a warning and a fine ranging from 500,000 yuan to 5 million yuan.
3. Reporting of Large Positions
The Interim Provisions require futures exchanges to formulate and publicize the large position reporting thresholds in respect of futures contracts, standardized options contracts, or underlying products. Futures exchanges are authorized to require trading participants to report information about their trading in domestic and overseas futures markets, over-the-counter (OTC) derivatives markets, and spot markets. To date, we have not seen any futures exchanges explicitly require trading participants to report OTC derivatives trading, and it remains to be seen when and how futures exchanges will impose such requirements.
According to Article 21 of the Interim Provisions, futures operating institutions, foreign brokers and traders shall ensure the authenticity, accuracy and completeness of the information that they submit; if futures exchanges require futures operating institutions, foreign brokers, or traders to provide supplementary information relating to their futures trading activities, the futures operating institutions, foreign brokers or traders shall cooperate. If any futures operating institutions or traders fail to fulfill the reporting obligations in accordance with Article 21, Article 130 of the Futures Law shall be referred to adopt penalties, including an order for rectification, a warning, and a fine of up to 1 million yuan.
It is worth noting that legal liabilities for foreign brokers differ from the above. If foreign brokers fail to perform reporting obligations in accordance with Article 21 of the Interim Provisions, or if they forge, alter or fail to keep the relevant materials as required, they shall be sanctioned according to the Administrative Regulations on Futures Trading and the Interim Measures on the Administration of Engagement in Trading of Domestic Specified Futures Products by Overseas Traders and Overseas Brokers. The legal consequences include a fine of up to 300,000 yuan, which is slightly lower than the provisions mentioned in the above paragraph.
4. Position Aggregation
The requirements on position aggregation are intended to prevent the breach of position limits upon aggregation. The Interim Provisions specify three circumstances where the futures positions shall be calculated on a consolidated basis, i.e., (1) the same trading participant has opened more than one trading code with different brokers; (2) the accounts are under the same de facto control; and (3) other circumstances as determined by the futures exchanges. The first two circumstances where positions should be aggregated are practices already existing in the market, while the third circumstance is a new provision, whereby the Interim Provisions authorize futures exchanges to determine other circumstances where positions should be aggregated. Notably, there is no exemption for position aggregation available in the first two circumstances, while for the third circumstance, the futures exchanges shall simultaneously provide the exemption for position aggregation and application qualifications for exemption under such circumstances and announce the same to the market.
We will continue to monitor developments regarding regulations and practice and keep our clients informed.