China to allow QFIIs to trade stock index futures

* Foreign investors only allowed to trade within quotas

* Domestic brokerage firms can spend own money more freely

BEIJING May 7 (Reuters) - China's securities watchdog has published draft rules that will allow approved foreign investors to trade stock index futures, the first step in opening up its local securities market.

But the Qualified Foreign Institutional Investors (QFII) will only be allowed to trade stock index futures for hedging purposes, and it will be counted as part of their existing investment quotas, according to the proposed rules published by the China Securities Regulatory Commission (CSRC) late on Friday.

China officially launched the QFII system in 2003, and Beijing had granted investment quotas worth $19.7 billion in total to 97 foreign institutions by the end of 2010 -- only a tiny proportion of China's 20 trillion yuan stock market.

CSRC has also decided to allow domestic securities brokerage firms to buy more products with their own money, a move towards deregulation that could potentially boost incomes of local securities firms. (Reporting by Zhou Xin and David Stanway)