Access for CTA Funds to Enter into China Futures Market

By:Lea Li

China's futures exchange market has developed quickly inrecent years. China has a complex regulatory regime regardingfutures markets and market participants which will impact how a foreign CTA canconduct managed futures business. At present, only a few products in theChinese commodity futures markets are open to trading by foreign CTA’sdirectly. The majority of commodity and financial futures can only be traded bydomestic Chinese entities or individuals. Therefore, a foreign CTA needs toenter the Chinese market first before it can truly conduct CTA business eitheras a fund manager or prop trader.

At present, a foreign CTA has three main ways ofentering China’s futures business.

1. QFII (Qualified Foreign InstitutionalInvestor) Scheme

A foreign institutional investor (“QFII”) can investin the China domestic securities market with the permission of the China SecuritiesRegulatory Commission (“CSRC”).

After the qualification is approved by CSRC, A QFIImay acquire an investment base quota up to a certain proportion of its AUM byway of the record-filing to the State Administration of Foreign Exchange(“SAFE”). If any portion of a proposed investment quota is in excess of thebase quota, the excessive portion must be approved by SAFE

Within the approved quota, a QFII may invest instocks, bonds, stock index futures, securities investment fund etc.

2.Offshore Access to China Futures Exchange

There are three futures exchanges in China which allowinternational investors to trade specific commodity futures. The summary is setforth below.

First, Shanghai International Energy Exchange startedto allow international investors to trade crude oil futures from March 26, 2018by four routes. The international investors may trade crude oil futures inShanghai International Energy Exchange (i) as a client of a domestic futuresfirm member; or (ii) as an overseas special non-brokerage participant; or (iii)as a client of an overseas special brokerage participant; or (iv) by tradingthrough an overseas intermediary.

Second, Dalian Commodity Exchangestarted to allow international investors to trade iron ore futures from May 4,2018 by two routes. The international investors may trade iron ore in DalianCommodity Exchange (i) as a client of a domestic futures firm member; or (ii)as a client of an overseas brokerage firm.

Third, Zhengzhou Commodity Exchangestarted to allow international investors to trade PTA futures from November 30,2018 by two routes. The international investors may trade iron ore in ZhengzhouCommodity Exchange (i) as a client of a domestic futures firm member; or (ii)as a client of an overseas brokerage firm.

3.Registration with Asset ManagementAssociation of China (“AMAC”)

A foreign invested company can be registered as anAMAC compliant fund manager so as to provide CTA fund management services inChina. Such foreign invested company shall satisfy the following requirements:(i) to be incorporated in China; (ii) the shareholder of the foreign investedcompany shall be a financial institution duly approved or licensed by thefinancial regulator of the country or region where it domiciles; (iii) thesecurities regulatory authority of the country or region where the shareholderof the foreign invested company domiciles shall have entered into Memorandum ofUnderstanding for Securities Regulatory Cooperation ("MOU") with theChina Securities Regulatory Commission (“CSRC”) or other institutionsrecognized by the CSRC; and (iv) meeting basic requirements relating toregistered capital, office, and qualifications of fund managers and riskcontrol professionals.

Generally, it takes a lot of efforts to register as afund manager with AMAC even assuming the regulatory requirements can be met; itis also quite expensive to set up an AMAC compliant corporate, administrative,and operational structure;

4.Establishment of a Consulting Company

A foreign asset management entity can set up aconsulting company to provide technical and consulting services (typicallysystematic and quantitative programs and strategies) to qualified Chinese fundmanagers or investment funds or managed account holders in exchange forconsulting fees in line with what a CTA does in the U.S. This route will enablea foreign CTA to enter the Chinese market fast by utilizing its back officetechnical and operational resources and at a low cost as it can avoid the needof AMAC registration (at least for the time being per the current regulatoryenvironment).

5.Establishment of a Trading Company

A foreign asset management entity can set up a tradingcompany (or other forms of corporate vehicles) to conduct proprietary tradingdirectly using its own capital without the need of raising funds in China, thusskipping the need of AMAC registration as well as the need of a local fundmanager as the partner; the prop trader can apply its own trading strategieswith the support of back office technical and operational resources; the proptrader only needs to work with a Chinese FCM with respect to trading accountopening, settlement, fund transfer, reporting, and other related matters.

Such trading company shall be established in the formof wholly foreign-owned enterprise (“WFOE”). The WFOE can open a bank accountand a commodity futures trading account after its establishment.

China imposes certain restrictions on the conversionof the registered capital in the form of foreign exchange in the basic capitalaccount into RMB in the operating account of the WFOE. The bank will review thesupporting documents for the conversion. The key is to show the capital afterconversion will be used for the business as approved and within the scope ofbusiness on the Business License of the WFOE. Therefore, the registered capitalof the trading WFOE can only be converted and used for trading activitiesindicated in the approved scope of the business. However, once the registeredcapital is used for the business operation and resulted in income in RMB, theWFOE has much more freedom in terms of the use of China-sourced RMB funds.

The past practices by other CTAs so far have generatedmixed effects. There had been high profile negative cases a few years ago whichresulted in tightened control over financial futures trading. There are alsocases that have generated discussions in the futures industry but withouttriggering regulatory consequences.