Beware of A-Shares Being Held Hostage — Stock Index Futures Should Be Delayed

Author: [Mu Zi]
Source: [Fund Analysis]
Article type: Regular article
Published: 2007-10-12 19:49:45
Column: Expert Perspectives

Writing such a title when stock index futures are practically knocking at the door may indeed seem a bit untimely. But if untimely words are correct, why shouldn't they be spoken? The key question, therefore, is: is launching stock index futures under current conditions truly timely? To discuss whether the futures launch is timely, the crux is whether the current spot market's maturity meets the basic objective requirements for a futures launch. On this point, there remain many things worth debating.

Though it has been cited by many before, the example that must be cited once again is the unforgettable 1995 government bond futures tragedy. The factors behind that tragedy were numerous, but one point cannot be ignored: the outstanding float of government bonds at the time was too small. A few institutions joining forces were sufficient to control the corresponding futures movement. As for the eventual emergence of two major camps in a showdown — that was merely the inevitable result of this manipulation dynamic splitting apart.

For today's A-share market, its manipulability is comparable to the 1995 government bond market. The core problem is that super-large-cap stocks have excessively small float ratios, yet this float can control an ultra-large-scale market. The speculative returns and risk costs here are completely out of proportion. In this column's previous article on the "Hong Kong Stock Express," it was explicitly stated: without a reasonable float, there can be no reasonable price. The biggest problem with China's stock market today is that super-large-cap stocks have float ratios far below the Securities Law's required minimum of 10%. A stock market under such conditions is inevitably one that can be easily manipulated.

Once futures trading emerges atop an easily manipulated spot market, such trading will inevitably lead to extreme speculative behavior. Currently there is no spot short-selling — meaning in the spot market, one can essentially only profit by going long, while the actual floating chips are extremely insufficient. It can be asserted that under such float conditions, the launch of index futures will enormously favor frenzied long-side behavior. Any short position in futures will ultimately be swallowed by frenzied short-squeezes. The chips are so few and the capital so plentiful that any short position is ultimately a dead end. The extreme frenzy of long-side behavior will push A-shares to uncontrollable heights in a short period, exhausting the A-share market's long-term developmental essence and spirit, ultimately leading to an intractable situation.

One view holds that once red chips and H-shares return in large numbers, the float conditions required for index futures would be met. But such returns have not changed the status of excessively low float ratios for super-large-cap stocks. The recently returned China Shenhua has an A-share float ratio of 6.33%, while China Construction Bank has a mere 2.7%. May I ask: isn't this adding fuel to the fire? Such ultra-low-float super blue-chips returning guarantees that each one launched gets speculated into the stratosphere. As for leveraging the ultra-low A-share float ratios to control A-share movement in order to manipulate the corresponding Hong Kong-listed stocks and profit from both sides — that's not exactly news either.

This column's previous articles have already pointed out: to bring A-share prices to reasonable levels and achieve convergence with H-shares, the simplest method is to bring super blue-chip float ratios in line with H-shares. It can be asserted: until super blue-chip A-share float ratios are adjusted to reasonable levels, launching stock index futures is untimely and will necessarily harbor enormous subsequent risks. It cannot even be ruled out that A-shares become held hostage, putting subsequent regulation into an impossible predicament.

Following the most normal capital market layering design, the spot market must be perfected before the futures market begins. Currently, A-shares are split between Shenzhen and Shanghai. A spot underlying design spanning two markets will create many inconveniences down the road. Ideally, the best approach would have been to first develop the ChiNext market, then after it reaches a certain scale, merge the main boards into Shanghai while Shenzhen becomes ChiNext, and finally launch index futures based on Shanghai — and correspondingly, Shenzhen could have its own ChiNext index futures.

Of course, the above approach has already missed its window of implementation, but this cannot be used as justification for premature futures launch that leaves serious hidden dangers. The simplest principle: futures are the product of a fully developed spot market. And the current A-share spot market still has many imperfections. Rushing to launch index futures — isn't that a bit like pulling seedlings to make them grow faster?

As for the argument that futures can hedge risk — that's not even worth rebutting. World securities history has repeatedly proven: the greatest risks have never come from the spot market but from highly leveraged positions and derivatives like futures. Whether futures can reduce spot risk is debatable; how to prevent the risks inherent to futures themselves is a far more thorny problem. And this problem applies not just to all participants but especially to market regulators.

Let's be blunt: the reason futures are currently eagerly anticipated by the market is simply that spot market specculators see the perfect opportunity to lock in speculative profits, and further see new speculative opportunities to magnify those profits. At present, the right course is to act against speculative capital's wishes, to pull the rug out from under them, to keep the initiative in the regulators' own hands. Perfect the market at the pace demanded by healthy development, rather than being led by the nose by speculative capital, creating a once-in-a-century opportunity for speculative capital to cash out and flee.

(Special Senior Advisor to this publication, Mu Zi)