October 22, 2014 / 1:11 AM / 4 years ago

Top bullion consumer China works on first gold forwards, options

SINGAPORE/SHANGHAI (Reuters) - The Shanghai Gold Exchange (SGE) is working on plans for China’s first forwards and options in gold, sources say, potentially putting China ahead in the race to set an Asian pricing benchmark that might eventually rival the London gold fix.

A customer looks at gold accessories at a gold store in Hangzhou, Zhejiang province April 16, 2013. REUTERS/China Daily

China, which overtook India last year to become the world’s biggest consumer of gold, bans trading in commodity options and forwards at present to limit speculation.

But Beijing is setting the stage for the launch of such derivatives as it opens up its markets, and gold could be among the first commodities on the list, although it remains unclear when trading might start.

The state-run SGE, at the forefront of China’s efforts to dominate bullion pricing, opened an international bourse last month and foreign banks have shown strong interest in trading its yuan-denominated contracts. The exchange now wants to expand its product line to boost liquidity.

Higher volume in gold trades open to foreign players could help China set a benchmark for gold in Asia, at a time when the century-old London fix is under regulatory scrutiny and in the process of being revamped to provide more transparency.

However, the SGE is likely to introduce gold options first on the main board for domestic players rather than on its new international board, according to two sources with knowledge of the plans. Foreigners are likely to see forwards first.

“We are eyeing the launch of gold forwards in the next six months to a year on the international board,” said a senior source at the SGE, who declined to be named because the plans are not final.

“Options are also in our pipeline but it may take longer and they are likely to be launched on the main board first, open to a few players.”

Forwards and options can be used for hedging, but also for speculative trading. Options give the investor a right but not an obligation to buy or sell an underlying asset at a specified price by a certain date. They are considered more speculative than forwards, which set a price for physical delivery at a future date.

“China wants to launch an options market and develop more derivatives instruments because they need to push for greater financial liberalization,” said Tan Xiaojun, a product analyst at Nanhua Futures.

“To do that, they will need to have bigger tolerance for speculative trade, but I think they are still very cautious on that end and the main consideration is still how much a certain derivative product can help end-users manage risks.”

China’s existing futures markets are dominated by retail investors, so the authorities may have to find ways to manage speculative trading by these investors in options and forwards while encouraging institutions to participate, analysts said.

SIMULATED TRADING

The SGE source said plans for both forwards and options were still at the exploratory stage and the launch of both would depend on regulatory approval. Officials at the SGE were not available for comment.

Other sources familiar with developments said regulators may give approval first to the Dalian Commodity Exchange’s corn options and then roll out options for exchange-traded funds and stocks ahead of gold, as those products are more mature and the exchanges involved have made the most thorough preparations.

China is cautiously opening up its economy to market forces and liberalizing its financial markets.

Part of that effort involved the creation of the Shanghai free trade zone and the launch of the SGE’s international bourse, allowing foreigners for the first time to directly invest in the country’s gold market using offshore yuan.

The SGE is not the only bourse interested in gold options.

Brokerage sources said the Shanghai Futures Exchange had been keen on launching gold options for a few years, but it has been distracted by preparations for after-hours trading for gold and a crude oil futures contract.

“They really haven’t had time and resources to put together a thorough plan for gold options. They’ve done some simulated trading but it didn’t take off because there was no liquidity,” said an executive at a large brokerage firm.

But plans are being firmed up now and the authorities are cautiously backing the moves.

China’s securities watchdog said last October the time was ripe for commodity options but no timetable has been set.

Analysts said a lack of brokers with experience in these financial instruments remained a challenge. [ID:nL3N0IF30Y]

China also has an immature market-making system with few institutions ready to quote both bid and offer prices, another problem for liquidity in options.

“Regulators are encouraging market players to develop (options) products,” said the SGE source.

“Both exchanges could launch gold options in the next few months, but I suspect volumes would be low as it would be open only to a few players,” the source said referring to the SGE and the Shanghai Futures Exchange.

Editing by Manolo Serapio Jr. and Alan Raybould

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