Further Moves of QFII Reform-Key Takeaways QFIIs need to know to trade PRC Futures and Options

From JUNHE|君合律师事务所

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Futures and Derivatives Law (FDL)- Is it only a framework?
It provides a framework for the regulation of OTC derivatives, but still with many details on the regulation of listed futures.
How are the futures and derivatives defined?
*Futures equals to exchange-traded futures and options
* Derivatives trading equals to OTC derivatives trading
-Making up insufficiency of definition of “securities”


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FDL-Is it only a framework?
Which authority has the jurisdiction?
*CSRC : equities , exchange-traded bonds, commodities as underlying
PBOC: CIBM bonds, interest rate and exchange rate as underlying
Where both regulators need to approve:

E.g.
√ CFFEX lists a new T-bond futures or options
√ CFFEX lists interest rate futures or exchange rate futures


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Key Takeaways QFIIs need to know
- Extraterritorial jurisdiction
“Futures trading, derivatives trading and related activities taking place outside the territory of the People’s Republic of China that disrupt domestic market order and impair the legitimate rights and interests of domestic traders, shall be handled and investigated for legal liability in accordance with this Futures and Derivatives Law.”


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Key Takeaways QFIIs need to know
-Real name account system
“Any entity or individual who, in violation of the provisions of the second paragraph of Article 18 of this Law, lends its proprietary futures accounts to others or borrow others’ futures accounts to conduct futures trading, shall be ordered to make rectification and be issued a warning , and it may be fined not more than 500,000 yuan. ”


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Key Takeaways QFII need to know
-Program trading
“Program trading conducted through automatic generation and delivery of trading orders by the computer programming shall comply with rules prescribed by the futures regulatory authority of the State Council, and shall be reported to the futures trading venues and shall not impact the system’s security or the normal trading order of the futures trading venues.”


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De Facto Controlled Account Filling
-What you need to know
-No longer a self-disciplinary rule
√ Legal consequences of violation
-Argument of fund managers
√Whether to aggregate the position and exchange’s practice

video content:

We’ll talk about a unique system –De Facto controlled account filing in China futures market. Such requirements already been seen in relative rules in each exchange. And it’s the first time FDL established such system at status level, requiring traders to make filing of de facto controlled relationships with the futures brokers of the exchanges in accordance with regulations that were prescribed by CSRC.

However FDL had not clarify definition of de facto controlled relationship and corresponding legal liability for violating such legal obligation. We understand that currently the exchanges have quite sophisticated rules regarding varied scenarios which the accounts being regarded as being in de facto relationship. And the legal consequence for violating the legal obligation.

In this regards, it remained to be seen whether CSRC will formulate specific measures for the de facto controlled relationship filing in the future. In terms of de facto controlled relationship filing the common questions came from fund managers and QFIIs on whether the fund products under management of the same manager shall file while conduct futures trading.

First, the definition of de facto controlled relationship from the exchanges are very broad, including having decision making power upon other persons’ trading decisions. So one can be captured in varied scenarios. The fund managers and QFIIs may argue that they have separated teams in charge of trading, separated accounts. So aggregation will not be needed due to such isolation of different trading desks while the exchanges looking into this issue and to determine.

Actually the isolation and separation are very difficult to achieve. As different teams may have the same strategy. Or they have different strategies but share the same middle office and back office. Also different teams may communicate with each other on how to deploy the strategy. So there can be a lot of details to make exchanges believe that they failed to achieve this kind of absolute isolation.

So it will be very difficult for QFIIs to argue that the positions should not be aggregated. So in other jurisdiction, some fund managers that can argue they can follow the guidelines, some clear criteria that they can be deemed as isolated. But in China, exchanges have no such detailed criteria. And they will look into circumstances. So QFIIs need to manage their expectations of whether they can achieve the real segregation.

Sometimes even the exchanges agreed to hear what did you said and what did you argued, it still depends on what evidence you can present to the exchanges, to prove that you are segregated. So the issue to be noted is that if QFIIs failed to do such filing, it’s a breach to the law and the legal consequence can be administrative penalties rather than previously only the exchange disciplinary measures. So QFIIs need to think about this.


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OTC Business-More Innovation and Less Regulation?
-Will overseas swaps still fly off the radar?
- Impact on HFTs
√Swap deal entered with broker
-Risk can not be underestimated
√ De Facto Controlled Account filing
√ Violation of Real Name Account System

video content:

Next common question comes from the offshore swaps. QFII may had entered swap with varied brokers. They will be beneficiary owners of the underlying assets. They may ask that will they need to do the filing. So from the brokers’ perspective, they will definitely say it’s not possible to make this kind of filing. The QFIIs are not actual owners of these accounts, they are just beneficiary owners. But still the QFIIs need to be very cautious about this issue. It still can be very risky. It will depends on whether QFIIs have the decision making power of these accounts. So if the QFIIs have such power and do the trading with multiple brokers. There are still risk of being asked to do de facto controlled relationships filing.Maybe the QFII said it only trade with one broker with one account so the risk of filing can be low.But still the risk of being regarded as breaching the real name account system can’t be eliminated. Also the current laws didn’t explicit prohibit the oversea swaps of trading,the legality of comprise such arrangement can still be questionable, for breaching the law through unregulated principles obtained until FDL.So if the underlying assets are domestic futures and options contracts, who can exclude the possibility that the regulators will deem such kind of arrangement is a breach of the real name account system established among the FDL.

So someone may argue that there’s no case precedent. But we have already seen case precedent in the security market. So the regulators will still look into the circumstances and determine whether there’s violation for penalty. So we need to bring this to QFIIs’ attention.


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Multiple Ways to access the PRC Futures Market
-Comparison between OFII channel and internationalization of specific futures products
Internationalization of Specific Futures Products
- 9 contracts
- Lower market entry thresholds
- Multiple routes
QFII channel
- 39 contracts
- Higher access conditions
- Stricker disclosure requirement