2021.05.13 XIE, Qing (Natasha)、Austin Zhang
On April 29, 2021, the Standing Committee of the 13th National People's Congress reviewed the Futures Law of the People’s Republic of China (Draft) (the “Draft Futures Law”) in its 28th session and published the full text of the Draft Futures Law for public consultation. This is the first time that the long-awaited Draft Futures Law, a milestone development of the derivatives markets, was unveiled to the public.
The Draft Futures Law proposes a total of 173 articles in 14 Chapters, bearing two predominated features: firstly, with respect to the exchange-traded derivatives, it recognizes the current legal framework established by the Administrative Regulations on Futures Trading (as amended in 2017), based on which it sets out and comprehensively improves rules for futures trading, settlement and delivery of futures and derivatives, traders protection, futures trading venues, futures clearing houses, futures operation institutions, futures service agencies; secondly, it provides, for the very first time, basic principles with regard to the regulatory framework of over-the-counter (OTC) derivatives, and authorizes the State Council to formulate detailed regulatory measures thereon, which tackles the long absence of legal provisions on the OTC derivative market.
Focusing on the common issues concerned by domestic and foreign futures market investors, this client briefing, as one of the article series that share our observations on the Draft Futures Law, highlights five key aspects, including scope of application, exchange-traded derivatives, market manipulation, insider trading and cross-border businesses. Regarding relevant analysis of OTC derivatives trading, please refer to JunHe Client Briefing “Single Agreement and Netting Provisions Concerning Other Derivatives Trading – Our Observations of the Draft Futures Law” and JunHe’s subsequent legal updates in this series.
The Draft Futures Law governs futures trading, other derivatives trading and related activities within mainland China, according to which, futures is defined as standardized contracts that are uniformly formulated by the futures trading venues for the future delivery of a certain number of underlying assets at a specified time and place, while other derivatives means non-standardized forward delivery contracts whose value depends on the changes in the value of underlying assets, such as non-standardized option contracts, swap contracts and forward contracts. It follows that this Draft Futures Law applies to trading of standardized exchange-traded derivatives and non-standardized OTC derivatives.
It seems that the Draft Futures Law broadens the concept of “futures” to include all standardized derivatives contracts traded in an open market, that is, as long as it is a “standardized derivatives contract” that “trades in an open market”, which are, in fact, two closely associated characteristics that bearing one would realize the other (specifically, those traded in an open market must be standardized contracts, and vice versa), such contracts shall then fall within the scope of “futures”. In addition, the Draft Futures Law introduces the concept of “other derivatives” to differentiate it from “futures” and aims to group all derivative contracts other than futures under the umbrella concept of “other derivatives”. In this regard, some experts from academic institutions and the futures industry are of the view that the name “Derivatives Law” is more accurate than “Futures Law” because the former name encompasses the actual applicable scope of this law.
The Draft Futures Law provides that the futures regulatory authority of the State Council (i.e., the CSRC) shall implement centralized and unified supervision and regulation on the national futures market (i.e., exchange-traded futures market), while two specific futures (i.e., the interest rate and foreign exchange rate futures) shall be otherwise stipulated by the State Council. It further provides that for the other derivatives market, the supervisory and regulatory body shall be a department authorized by the State Council. It can be inferred that the Draft Futures Law does not intend to change the current regulatory framework that separates regulatory authorities by varieties of underlying assets and different market participants, but it does propose a high-level programmatic legislation, under the principles and framework of which, competent regulatory authorities may, based on the varieties of underlying assets and different market participants, regulate their own market according to their statutory duties.
The Draft Futures Law codifies certain stipulations for exchange-traded futures, covering trading mechanism, risk control, supervision, and regulation. In particular, it specifies that centralized trading, margin trading, position limits, mark-to-market settlement mechanism, physical delivery/cash settlement, forced liquidation and other relevant systems shall be implemented in exchange-based futures trading, which remains aligned with the Administrative Regulations on Futures Trading. It is also noteworthy that the Draft Futures Law, to some extent, codifies certain current rules and puts forward legislation on certain existing practices in futures markets for the first time. Below are our detailed analysis of these rules and their implications.
2.1 Real-Name Account System
According to the Administrative Regulations on Futures Trading, futures companies must open a separate account and set up a separate trading code for each client, mingling clients’ codes is prohibited (such requirement is known as “One Client, One Code”). “One Client, One Code” is in effect the requirement for “real-name account”, which is confirmed by the Draft Futures Law. To be specific, the Draft Futures Law explicitly prohibits traders from opening an account in another's name, using a false identity, or lending their own identification documents to others for opening an account. Further, drawn from relevant rules in the Securities Law (amended in 2019), it also stipulates that no entity or individual shall lend its own futures trading accounts to others or borrow others’ futures trading accounts for engaging in futures trading, or it shall be ordered to rectify the matter, be issued a warning, and be fined not more than RMB 500,000.
2.2 Regulations on Suitability of Traders
Based on Article 57 of the Administrative Measures on Supervision on Futures Company, which provides that futures companies shall implement the system of suitability of investors, the Draft Futures law categorizes futures traders into “ordinary traders” and “professional traders”, of which the qualification standards for “professional traders” shall otherwise be formulated by the CSRC. We expect that such qualification standards for “ordinary traders” and “professional traders” may be drawn from the relevant criteria for determining “ordinary investors” and “professional investors” in the Administrative Measures for Suitability of Securities and Futures Investors issued by the CSRC in 2020.
In addition, under Article 57 of the Draft Futures Law, legal persons and unincorporated organizations engaging in futures trading shall establish an internal control policy and a risk control policy that adapt to the type, scale, and purpose of the contracts they trade. We note that institutional investors have been required to submit their policies with respect to internal control and risk management if they trade futures contracts in Shanghai International Energy Exchange (INE). It remains to be seen how such requirements by INE can be applied more broadly.
2.3 Regulations on Program Trading
Consistent with the Securities Law (amended in 2019), the Draft Futures Law stipulates that program trading conducted through automatic generation and delivery of trading orders by 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 security or the normal trading order of the futures trading venues. Article 141 provides for corresponding legal liabilities for violators. For example, if any entity or individual conducts program trading without reporting it to the futures trading venues, it shall be ordered to rectify the matter, be issued a warning and may be fined not more than RMB 1 million; if an adoption of program trading impacts system security or the normal trading order of futures trading venues, the wrongdoer shall be ordered to rectify the matter and be fined not less than RMB 500,000 but not more than RMB 5 million.
Currently, each futures exchange has already had in place rules to regulate program trading for a long time, under which reporting of program trading is required. We expect that the CSRC may further consider and provide specific requirements for program trading in relation to both securities and futures markets.
2.4 Reporting a De Facto Control Relationship
Reporting a de facto control relationship is a unique system only required in futures trading. The Draft Futures Law stipulates that traders shall report the de facto control relationship to the futures operation institutions or the futures trading venues -- the first time that such a “reporting system” is specified in law, not only in a regulation or exchange rule. The definition of a de facto control relationship under the Draft Futures Law is consistent with that in the administrative measures for futures accounts with a de facto control relationship currently implemented by each futures exchange, that is, the act of having or the fact that an individual or an entity has the authority to manage, use, obtain earnings from or dispose of futures accounts of another person or entity and thus has decision-making power or significant impact upon another person or entity’s trading decisions. According to the Draft Futures Law, those violating the “reporting obligation” shall be ordered to rectify the matter, be issued a warning, and be fined not more than RMB 500,000.
2.5 Margin System
Pursuant to the Administrative Regulations on Futures Trading, traders may post cash or other negotiable securities with stable value and high liquidity such as standard warrants and treasury bonds (the “Margin”) for settlement of futures trading and guarantee of the performance of contracts. The Draft Futures Law broadens the scope of eligible margins to cash, treasury bonds, stocks, fund units, standard warehouse receipts and other negotiable securities with high liquidity, as well as other assets stipulated by the CSRC.
The ownership rights to the margins and protection of margins in a bankruptcy proceeding are key concerns of foreign institutional participants. Unlike the Administrative Regulations on Futures Trading, which stipulates that the margins collected by futures exchanges from members shall belong to members, and those collected by futures companies from clients shall belong to clients, the Draft Futures Law specifies requirements for “segregation” and “proper use”, that is, margins and premiums collected by futures clearing houses and settlement participants shall be kept separately from their own funds, deposited in a special account, and managed separately; Misappropriation of such margins or premiums for any purpose other than those stipulated by the CSRC is prohibited (which is the same as the requirements in the Administrative Regulations on Futures Trading and the Administrative Measures for Supervision on Futures Company).
With respect to protection of margins and relevant assets in a bankruptcy proceeding, the Draft Futures Law provides that, where futures companies (as settlement participants), or futures traders enter into bankruptcy or liquidation proceedings, the margins and deliverable assets in the physical delivery shall be preferentially used for settlement and delivery. It also provides that, where the futures margin depository institution (i.e., the depository bank) goes bankrupt, the margins, premiums and the relevant assets shall not be treated as bankruptcy assets. However, it does not specify how to protect the margins delivered by settlement participants to futures exchanges under the circumstances that the futures exchanges go into bankruptcy. We guess that the silence of Draft Futures Law on the requirements for property segregation under the circumstances that futures exchanges go into bankruptcy may be due to the inherent particularities of China’s futures exchanges.
Furthermore, we note that according to the Administrative Measures for Supervision on Futures Company, margins and other entrusting assets posted by clients shall not be seized, frozen, deducted, or forcibly enforced unless for the purpose of payment for the client’s own debts, or otherwise stipulated by laws and regulations. However, the Draft Futures Law only provides that margins, premiums, settlement guarantee funds, risk reserve funds and such other assets collected and withdrawn by futures clearing houses pursuant to its business rules shall not be seized, frozen, retained, or forcibly enforced. We hope that the final Futures Law will clarify that, being consistent with the current stipulations, margins posted by clients shall not be seized, frozen, deducted, or forcibly enforced unless for the purpose of payment for the client’s own debts, or otherwise stipulated by laws and regulations.
2.6 Central Counterparty
In April 2012, the Committee on Payment and Settlement Systems (CPSS) and the International Organization of Securities Commissions (IOSCO) issued the Principles for Financial Market Infrastructures (PFMI), which establishes international standards for central counterparties in terms of general organization, credit and liquidity risk management, settlement, defaulting management, general business and operational risk management as well as access, efficiency and transparency, under which only those that satisfy the PFMI requirements and are recognized by regulatory authorities in their home jurisdictions can be deemed as qualified central counterparties.
The Draft Futures Law, for the first time at the statute level, recognizes the futures clearing houses, as well as the futures trading venue with an internal settlement department, as central counterparties that are responsible for carrying out net settlement and provide guarantees for centralized performance of futures trading. Up to now, the CSRC has approved five futures exchanges to be “qualified central counterparties”. Moreover, the Draft Futures Law explicitly confirms the rule for settlement finality, in line with the Securities Law (amended in 2019), meaning that the outcome of a transaction conducted pursuant to the business rules formulated by the futures trading venues shall not be varied, and net settlement made pursuant to the relevant provisions shall not be affected by the commencement of bankruptcy proceeding of either party. Under this provision, the futures exchanges may settle and arrange delivery of cash and contracts for futures trading on a net basis, and the settlement results therefrom shall be final and cannot be invalidated and rescinded by an administrator in accordance with the Bankruptcy Law of the People’s Republic of China.
Additionally, in relation to the fast disposal of collaterals, the Draft Futures Law provides that futures clearing houses and settlement participants (as each case may be) may directly dispose of collaterals such as negotiable securities used as margins under the circumstances that margins posted by settlement participants or traders do not comply with the required standards, and they fail to provide additional margins or voluntarily close positions within the prescribed time limit.
The market manipulation activities set out in Article 241 of the Draft Futures Law basically remain consistent with those in Article 702 of the Administrative Regulations on Futures Trading and the Provisions for “Other Acts of Futures Trading Price Manipulation” in Section 5, Article 70 of the Administrative Regulations on Futures Trading (the “Provisions for ‘Other Acts of Futures Trading Price Manipulation’”). Notably, both item (4) (commonly known as “false information manipulation”) and item (6) (commonly known as “scalping manipulation”) in Article 24 of the Draft Futures Law prescribe criteria different from the current Provisions for “Other Acts of Futures Trading Price Manipulation”. We would suggest the criteria for such specific futures market manipulations be further clarified.
Based on the Administrative Regulations on Futures Trading, the Draft Futures Law further specifies insider trading with respect to the following aspects:
4.1 Expand the scope of Insider Information. Insider Information means any non-public information that may have a significant impact on the futures trading prices in futures trading activities, which include:
(1) Policies, information, or data being formulated or yet to be released by the futures regulatory authority of the State Council or other relevant departments that may have a significant impact on the futures trading prices;
(2) Decisions made by the futures trading venues, futures clearing houses or futures industry associations that may have a significant impact on futures trading prices;
(3) Trends of funds and trading activities of members and traders in the futures trading venues;
(4) Information on significant abnormal trading in other related markets;
(5) Other information that has a significant impact on the futures trading prices as determined by the futures regulatory authority of the State Council.
4.2 Expand the scope of the definition of insider. Under the Draft Futures Law, insider is defined as any entity or individual who has access to or is able to obtain insider information due to their management status, supervisory status, business status or convenience of their positions. Apart from staff of the CSRC and other relevant departments, it explicitly broadens the scope of insiders by specifying that insiders may also include relevant personnel of the futures operation institutions, futures trading venues, futures clearing houses, futures service agencies and futures industry associations, and any other entity or individual that has access to insider information due to their positions as determined by the CSRC.
4.3 The Draft Futures Law considerably increases the ceiling on and the range of the fine amounts, for example:
(1) Besides a confiscation of illegal gains, a concurrent fine has been increased from five times the amount of illegal gain to ten times;
(2) In the event of market manipulation, where there is no illegal gain or the illegal gain is less than RMB 1 million, the maximum fine has been increased to RMB 10 million; where any entity engages in market manipulation, the maximum fine imposed on the relevant responsible person has been increased from RMB 100,000 to RMB 5 million.
(3) In the event of insider trading, where there is no illegal gain or the illegal gain is less than RMB 500,000, the maximum fine has been increased to RMB 5 million; where any entity conducts insider trading, the maximum fine imposed on the relevant responsible person has been increased from RMB 300,000 to RMB 2 million.
4.4 It is noteworthy that same as exchange-traded derivatives, the regulatory authorities may also impose relevant administrative penalties as stipulated by the Draft Futures Law on anyone who, in OTC derivatives trading, engages in market manipulation, insider trading, fabricating or disseminating any false or misleading information, and other illegal activities.
5.1 Extraterritorial Jurisdiction
With reference to the Securities Law (as amended in 2019), Article 2 of the Draft Futures Law stipulates that futures trading, other derivatives trading and related activities conducted outside mainland China that disrupt domestic market order and impair the legitimate rights and interests of domestic traders shall be subject to this Futures Law.
Up to now, foreign investors may engage in domestic futures trading and other derivative trading mainly via the following channels:
(1) A foreign investor with a Qualified Foreign Institutional Investors (QFII) license or RMB Qualified Foreign Institutional Investors (RQFII) license (the QFI Scheme) is allowed to trade permissible listed futures and options products.
(2) A foreign investor who satisfies the requirements for access to China Interbank Bond Market (CIBM Direct) (including QFI) is allowed to trade bond-type, interest rate-type and foreign exchange-type derivatives;
(3) Trading specific domestic-listed futures products;
(4) Setting up a wholly foreign-owned entity (WFOE) or joint venture in mainland China to trade domestic futures products with their legitimate RMB income;
(5) Trading foreign structured investment products or OTC derivatives products that link to domestic underlying assets such as futures, options and others.
Such foreign OTC derivatives transactions (for example, Total Return Swap (TRS)), usually tailor-made by foreign brokers for their institutional clients, enable foreign investor to gain economic exposure to domestic underlying assets indirectly without inconvenience and high costs for pursuing relevant cross-border qualifications (such as QFI). Although Chinese laws and regulations do not explicitly prohibit or restrict such OTC derivatives trading, it may give rise to concerns about contradicting with the look-through regulatory principle. In the 2021 Boao Forum for Asia held on April 19, 2021, Fang Xinghai, the Vice-Chairman of the CSRC, said that the CSRC attaches great importance to the regulation on foreign investors and the CSRC can look through to the ultimate beneficiary owner of investors engaging in domestic securities markets via QFI Scheme and Stock Connect. Though only the securities market was mentioned in his speech, the CSRC’s regulatory approach of look-through, we believe, may also be applied to the futures markets.
5.2 Cross-Border Businesses
The Draft Futures Law puts forward the applicable rules for the registration and exemption of cross-border futures businesses at the statute level for the first time:
(1) Overseas Futures Trading Venues: The Draft Futures Law requires overseas futures trading venues that provide domestic entities or individuals with direct access services to their trading systems to register with or apply for an exemption of registration to the CSRC. In addition, derivatives contracts listed on overseas futures trading venues and settled according to the prices of contracts listed on domestic futures trading venues shall comply with the provisions stipulated by the CSRC.
(2) Overseas Futures Operation Institutions:According to the Draft Futures Law, an overseas futures operation institution is required to register with or apply for an exemption of registration to the CSRC under any of the following two circumstances: (a) it is sub-entrusted by a domestic futures operation institution to conduct overseas futures trading; (b) it is entrusted by overseas entities or individuals to directly engage in futures trading in domestic futures trading venues. Pursuant to the relevant provisions on trading specific domestic-listed futures products, subject to approval by the futures exchanges, qualified overseas brokerage institutions may be entrusted by overseas traders to directly trade specific domestic-listed futures products in its own name. Up to now, INE has approved two overseas brokers to engage in INE-listed futures trading as entrusted by overseas entities or individuals. However, it needs to be clarified whether such brokers are also required for registration or exemption with the CSRC.
(3) Marketing and Relevant Activities: Pursuant to the Draft Futures Law, overseas futures operation institutions and any other overseas organizations that, directly or through their branches established in mainland China, engage in activities of marketing, promotion and solicitation traders in domestic futures markets shall obtain approval of the CSRC. Without approval of the CSRC, no entity or individual shall engage in marketing, promotion or solicitation activities for overseas futures trading venues and overseas futures operation institutions. This is the first time that, the futures-related legislation proposes regulations on overseas institutions engaging in marketing, promotion and solicitation activities in domestic futures markets, however, determination factors of marketing, promotion and solicitation activities require further clarification.
(4) Cross-Border Regulatory Cooperation Mechanism: According to the Draft Futures Law, the CSRC may establish a cooperative mechanism for supervision and regulation with overseas futures regulatory authorities to implement cross-border supervision and regulation, carry out cross-border investigations and collect evidence, pursue legal liability and cope with cross-border market risks; without judicial agreements or reciprocal arrangements, an overseas futures regulatory authority is prohibited from directly carrying out law enforcement activities such as investigation and evidence collection within mainland China. In addition, without consent of the CSRC and the relevant departments of the State Council, no entity or individual shall provide documents and materials relating to futures business activities to an overseas party. We note that the foregoing requirements are also consistent with the Securities Law (as amended in 2019).
Following the amendment to the Securities Law in 2019, the Draft Futures Law is undoubtedly another milestone in the history of China’s legislation on financial markets and marks a new era for China’s derivatives markets, with a far-reaching positive impact on the growth of such markets. We will continue to monitor the situation and keep our clients apprised of any important developments.
1.The Draft Futures Law, Article 24: The following misconduct that affects or has the intention to affect the futures trading prices or futures trading volumes, each of which shall be determined as futures market manipulation activity and is prohibited: (1) independently or in collusion with others, concentrating advantages of funds or positions, or taking advantage of information to trade or conducting consecutive trading; (2) conspiring with others to carry out mutual futures trading at an agreed time, price and method; (3) conducting self-trades of futures contracts; (4) making use of significant information that is false or uncertain to induce traders to trade futures; (5) without genuine transaction purposes, frequently placing and then canceling orders or placing and canceling large-value orders; (6) having held relevant contracts, making public evaluation or forecast, or providing investment recommendations with respect to relevant futures trading or trading of underlying assets of relevant contracts; (7) stocking up physical products with the intention to affect the futures markets; (8) gaining position advantages by using improper means to circumvent position limits on the futures contracts which are near or in their delivery month; (9) making use of activities in other related markets to manipulate the futures markets; (10) other means of manipulating the futures markets as determined by the futures regulatory authority of the State Council.
2.The Administrative Regulation on Futures Trading, Article 70: Any entity or individual committing one of the following acts, manipulating futures trading prices shall be ordered to rectify the matter, its illegal gains shall be confiscated, and be fined not less than one time but not more than five times the amount of illegal gain: (1) manipulating the futures trading prices by, independently or in collusion with others, concentrating advantages of funds or positions, or taking advantage of information to trade or conducting consecutive trading; (2) colluding with others and engaging in futures trading with each other at such time and price as agreed to affect the trading prices or trading volume of futures contracts; (3) conducting self-trades of futures contracts to affect the trading prices or trading volume of futures contracts; (4) cornering spot commodities in order to affect the futures market conditions; (5) other acts of futures trading price manipulation as stipulated by the CSRC.