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Market News
Stock Index Futures: A Tool for Risk Management

Source: People’s Daily
By He Qiang


Financial derivatives market is a key part of a multilayered capital market, and is the fundamental mechanism and strategic arrangement for risk mitigation and economic growth under the New Normal. It helps to improve the multilayered service system of the capital market, and promote optimized resource allocation, economic resilience, mitigate risk accumulation, safeguard financial security, and push forward sound economic development. The stock index futures have been launched in China for over 6 years. It is time for us to provide clearer market positioning, enhance supervision, promote orderly development, keep it functioning on the right track and bring its role into full play.

Established risk management tools in developed markets

Experience in developed countries and regions indicate that economic innovation and growth require the support by a sound capital market, which relies on diversified financial risk management tools. Take US market in the 1970s for instance, the breakdown of the Bretton Woods System, unpegging of USD from gold, less stable internal and external value of currency, increasing fluctuations of interest rate, FX rate, stock price and other economic variables drove commercial banks, investors and businesses to call for effective risk avoidance and management financial tools. In this context, the US launched a number of new derivatives like financial futures/options and started the new era of financial derivatives (FDs) .

FDs, by dispersing and transferring, can re-allocate the risks; particularly the financial futures could transfer out the pricing uncertainties of financial assets through intensive standard contract transaction, and investors need only bear the risks that they can manage. The risks hard to control will be passed to the ones who are capable and willing to bear. This makes FDs an active and effective risk management tool for market participants. Global long-term practice indicates that FDs are able to improve the risk tolerance of the whole economic and financial system through the use of price discovery and risk management and other functions and therefore support the development of real economy.

Correctly understanding the relationship between futures and spot products

In 2015 China’s stock market suffered unusual fluctuation, and people held different views on the performance of stock index futures, believing that it was the stock index futures that led to the crash. The event in fact was triggered by deleveraging, which resulted in capital flight and the later slump in 2015.

Market operation shows that stock index futures play a positive role to some extent. During the 2015 crash, some funds avoided risks through hedging and mitigated investment loss. Such hedging helped investors to lock on risk and profit and build confidence without selling out stocks when the market went gloomy, and thus enhanced the internal stability of stock market.

Further improvement of the hedging mechanism

As the next step we need to make long-term plan and study on how to make full use of the hedging function of the futures for risk avoidance and more diversified risk management tools.

1. Identify the basic goal of setting up FDs market and launching of stock index futures: which, in my view, is to bring their risk management role into full play and take it as the primary task of development. We have to provide risk management tool through making use of the hedging function of index stock futures. Through the use of price discovery, it will also help form the basis of rational pricing for stock market.

2. Encourage hedging to prevent excessive speculation: the speculation factors in FDs market play the role of risk transfer and liquidity production. However, too much speculation will be contrary to the fundamental purpose of market development. We need to learn from the experience of the crash, optimize trading rules, and reduce speculation at institutional level. We have to improve frontline regulation to avoid excessive speculation and other irrational trade, and control risks to ensure stable market operation. In addition, we need to provide comprehensive hedging services, and make hedgers the major market players.

3. Enhance supervision, and prevent violations and misconducts: we have to enhance real-time and dynamic supervision of FDs market, strengthen client review, learn their actions promptly, analyze abnormal transactions in a timely manner, and crack down on any violations once spotted.

4. Further diversify stock market risk avoidance tools: We shall consider bringing back the stock index futures to the right track while carrying out the above tasks. By looking forward, the existing products are not able to fully meet the market demand, and we have to enrich stock market risk-avoiding tools and launch various types of FDs products in order to improve the stock market risk management system and better serve the capital market.

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