CHINA MONEY-China govt bond futures to start with a whimper, not a bang
* Govt bond futures to restart Friday after 18-year halt
* Trading expected to be slow at beginning on risk controls
* Mild inflation set to keep prices relatively stable
* Major players, banks and insurers, cannot trade for now
By Lu Jianxin and Pete Sweeney
SHANGHAI, Sept 5 (Reuters) - China government bond futures trade is set to restart quietly on Friday after an 18-year hiatus, with market enthusiasm crimped by tight risk controls and a benign inflationary environment.
Beijing is moving to financial innovation to drive growth while reducing systemic risk from sloppy lending practices, and the reintroduction of a government bond futures market -- closed since 1995 after a trading scandal -- is part of that drive.
Analysts say that while caution is warranted, the risk controls in place for the new market are so severe that it cannot serve its intended purpose until they are eased.
The first major barrier is the absence of key participants.
As a risk hedging tool, government bond futures are meant to play a key role in encouraging Chinese banks to loan to private businesses and a prerequisite for liberalising deposit rates, delivering higher returns to Chinese savers.
The hope is that this will drive growth both by allocating capital to more efficient parts of the economy and increase the propensity of ordinary Chinese people to consume.
But Chinese commercial banks and insurers, both major holders of government bonds, are still waiting for approval to trade in the futures market.
Out of China's outstanding 7.57 trillion yuan ($1.24 trillion) worth of tradable government bonds -- more than 70 times the value of such bonds in 1995 -- banks alone hold 5.23 trillion yuan, or 69 percent, insurers hold 4 percent, while funds and brokerages hold a combined only 1.5 percent, data published by the government's bond trading clearing house shows.
But so far only major brokerages with proprietary securities trading licences can trade futures freely; others, including mutual funds, can only do so for hedging purposes.
Individuals will also be allowed to participate, but they must have at least 500,000 yuan ($81,700) in their margin accounts to trade the futures.
Analysts said the exclusion of banks is likely temporary, but betrays a high degree of caution from regulators, specifically the central bank, the China Banking Regulatory Commission and the China Insurance Regulatory Commission.
Liu Wenbo, a specialised analyst at Shanghai CIFCO Futures Co, pointed out that banks have a key role to play in deterring the sort of excessive speculation that destroyed the market last time around.
"Given they have so many outstanding bonds on hand, financial institutions can easily correct rates if excessive arbitrage drives prices to extremes," he said.
But even if banks are allowed into the market, the current macroeconomic environment will restrain its growth.
"The key factor that will prevent new government bond futures from the sort of speculation seen in the 1990s is the benign inflation environment," said Liu Zhongyuan, a veteran Chinese futures market player and chief economist at ChangJiang Futures Co.
"With few expecting rate cuts or rises in the near term, small returns caused by mild price volatility will dampen investor interest."
China's consumer price inflation stood at 2.4 percent in the first seven months of this year, down 0.7 percentage points from the same period a year earlier, well within range of the government's target of 3.5 percent for 2013.
Thus, the People's Bank of China (PBOC) is not likely to raise or reduce benchmark interest rates for the rest of the year. This will confine spot bonds yields within narrow ranges and cap fluctuations of futures prices, analysts say.
In comparison, China's annual inflation rate was more than 20 percent, which lasted for several years in the mid-1990s.
RULES, RULES AND RULES
The China Financial Futures Exchange (CFFEX) will kick off futures trading on Friday with three five-year contracts, with margin requirements being set higher than the legal minimum at the beginning.
"To tightly control risk at the start of listing, margin requirements for these contracts will temporarily be set at 3 percent," the exchange, established in 2006 to host trading of China's fledging derivatives, said in a statement this week.
Exchange rules issued last week prescribed minimum margin requirements for government bond futures at 2 percent, rising to 3 percent on the 10th of the month ahead of the delivery month, and 5 percent on the 20th.
The rules also cut the limit of holdings of one contract by a single participant for speculation to 1,000 lots from 1,200 lots proposed in draft regulations in July, falling to only 100 lots on the 20th of the month ahead of the delivery month, from 300 lots originally proposed.
($1 = 6.12 Chinese yuan) (Editing by Jacqueline Wong)
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