Demand For SGX FTSE China A50 Index Futures Rises To A New Level

• China’s influence in the world has continued to evolve, with recent industry reports estimating Mainland household wealth doubling from US$16.5 tr to US$35 tr by 2015.
• Yesterday, PowerShares, a leading ETF provider, launched a new ETF that tracks the FTSE China A50 Index.  The ETF will invest primarily in the SGX FTSE China A50 Index Futures to track the Index.
• The SGX FTSE China A50 Index Futures are attracting a wide array of investors, providing an investable asset with high correlation to the onshore China market and offering 16.5 hours of trading each day.
• Liquidity and volume in the SGX FTSE China A50 Index Futures continue to soar - the contract achieved an average daily volume of 88,729 contracts and an open interest level of 202,547 contracts in September.

   

The FTSE China A50 Index Futures contract (ticker: XUA Index) listed on Singapore Exchange (SGX) is recognized as the premier offshore investment vehicle for the China A-shares market.

On 10 October 2013, leading exchange traded fund (ETF) provider PowerShares, launched the first U.S. listed ETF China A-Share Portfolio (ticker: CHNA), providing  investors with exposure to the China A-shares market.  The ETF will invest primarily in the SGX FTSE China A50 Index Futures (SGX A50 Futures).

To date, the equity market for China A-shares has been largely closed to investors outside of mainland China, due to foreign exchange controls and restrictions on ownership. Foreign investors can only participate through the QFII and RQFII schemes which require regulatory approval by Chinese authorities.  

“U.S. investors currently have very limited access to China’s domestic A-Shares market, which embodies the amazing growth story of the world’s second largest economy by GDP,” said Lorraine Wang, Invesco PowerShares global head of ETF products and research. “The PowerShares China A-Share Portfolio is uniquely designed to provide a liquid, efficient and cost effective alternative to direct investments in China A-Shares. The portfolio utilizes the China A50 contracts traded on SGX, a leading Asian marketplace providing cleared products that remove credit risk from financial transactions”

China is experiencing phenomenal growth.  The charts below show that China has become a leading commodity consumer with a CAGR in excess of 8% in recent years.  Most notably:

1. China surpassed Japan in 2010 to become the second largest global economy.
2. Increasingly, contracts are being priced in RMB – a sign of the growing influence of China.
3. Mainland China household wealth is expected to double from US$16.5 trillion today to US$35 trillion by 2015 (Credit Suisse Global Wealth Report)

   

   

Global index providers like MSCI and FTSE have reportedly been engaged in discussion with industry practitioners and government officials to review the potential of China A-shares being included as a constituent in their global equity benchmark indices.

According to Liu Lijun, CEO of China Universal Asset Management, their research indicates that an inflow forecast of more than RMB1 trillion (approximately US$160 billion) to the A-shares market is quite reasonable. This is in line with the US$180 billion estimate from Deutsche Bank’s China strategists, who are “optimistic” that over the next two to three years, the China A-shares will be included (at least partially) in one or more major global benchmarks¹.

The advent of offshore investment products led by the SGX A50 Futures and the PowerShares China A-Share Portfolio will provide investors access to the China economy coupled with the additional benefit of portfolio diversification. The benefits of international diversification are well-known to fund managers and hedge funds.  Pioneering work by Harry Markowitz dating back to 1952, now the cornerstone of modern portfolio theory, demonstrates the benefits of diversification.  This model relies on the benefits of diversification when additional assets are added to a portfolio that are not perfectly positively correlated with the existing portfolio.  The lower the level of correlation; the greater the benefit.

Research by Chiang, Lao and Xue² provides evidence of a relatively low correlation between China and US equity markets; less than 0.20, and less than 0.30 with the European equity markets.  These low correlations are evidence of the diversification and portfolio enhancing power of the China A-shares. 

SGX FTSE China A50 Index Futures

The recent expansion of QFII and RQFII quotas and relaxation in usage restrictions have given rise to the rapid proliferation of China A-shares products for foreign investor use. The product range has expanded from synthetic and physically-backed ETFs to leveraged fund structures, as well as the SGX A50 Futures which are the world’s only offshore futures tracking the China A-shares market.

U.S. dollar denominated, SGX A50 Futures have attracted a wide array of global users. Market-makers, CTAs and relative value managers are actively managing multiple trading and investing opportunities between the A-share baskets, ETFs and the futures listed within China and on SGX, as well as the offshore listings of secondary H-share China products.

More recently, asset managers have made use of the liquidity in the SGX A50 Futures to create innovative index funds. Earlier this year, Samsung Asset Management launched the first China A-share Leveraged Fund in Korea. The fund tracks the FTSE China A50 Index, but amplifies the underlying index by 1.5 times by utilising the SGX A50 Futures.

Quick facts about the SGX A50 Futures contract:

1. High liquidity: Average daily volume of 88,729 contracts with open interest of 202,547 contracts in Sep 13.
2. Cleared by SGX’s Award-winning Clearing House in AAA-rated Singapore.
3. CFTC approved for trading by U.S. investors.
4. Longest trading hours in Asia: 16.5 hours of trading.
5. High correlation with the onshore CSI 300 Index futures: >96%.
6. Close tracking of the spot index: SGX A50 front month futures’ premium over cash averaged -0.29% for 2013 YTD.

Committed market-makers providing a tight bid-offer spread of 8 bps during Asian hours.  

        The growth in volume and open interest reflects the market’s increased use of the contract and recognition as a hedging and investment instrument.  Daily average volumes are now in excess of 80,000 contracts.  The volume increase has also resulted in reduced transaction costs for traders as seen by the bid/offer spread below. The average bid-offer spread during the period below is approximately 8 basis points, or about US$5.80.  The second chart shows the pace and percentage of roll from the August 2013 contract to the September 2013 contract.  The percentage of positions rolled approaches 100%, indicating a strong desire by the market to maintain their exposure via the SGX A50 futures.    

   

SGX FTSE China A50 Index Futures Contract Specifications

   

Underlying Index	FTSE China A50 Index
Trading Hours	9:00am – 4:00pm (T session) 4:40pm – 2:00am following day (T+1 session)
Contract Size	US $1 x SGX FTSE China A50 Futures Price (approximately US $7500 as of 9 Oct, 2013)
Contract Months	2 Serial and 4 Quarterly months in the Mar, Jun, Sep and Dec cycle.
Settlement Method	Cash settlement
Final Settlement Price Methodology	The Final Settlement Price shall be the official closing price of FTSE China A50 Index rounded to the nearest 2 decimal places.
Daily Price Limits	Whenever the price moves by 10% in either direction from previous day’s settlement price, trading at or within a price limit of 10% is allowed for the next 10 minutes. Thereafter, trading is allowed at or within a price limit of 15% in either direction from the previous day’s settlement price. When this limit is reached, there shall be a further 10-minute Cooling Off Period in which trading is allowed at or within a price limit of 15%. After which, there shall be no price limits for the remainder of the trading day There shall be no price limits on the last trading day of the expiring contract month
Last Trading Day	2nd last business day of the expiring Contract Month

   

The FTSE China A50 Index

The FTSE China A50 index is a free float adjusted, liquidity screened index comprising of the 50 largest A-share companies by full market capitalisation of the securities listed on the Shanghai and Shenzhen stock exchanges. It is reviewed quarterly in March, June, September and December to ensure the index remains representative of the underlying China market. The table below shows the top 20 component stocks in the index.

¹Source: “China A-Shares Going Global: How Will It Affect Asset Allocation?” by Samuel Lum, CFA, 6 August 2013.

²Source: “Empirical Evidence of Comovements between China and Global Stock Markets” by Thomas C. Chiang, Lanjun Lao and Qingfeng Xue, 17 August 2013.