Remarks by Leo Melamed at the Annual BOAO Forum 2015
Hainan Province, China
March 26, 2015
Mr. Chairman, distinguished guests, ladies and gentlemen. I am honored and delighted to once again speak at this impressive forum. My remarks today will be focused on the growth of futures markets in China and their immediate future.
At the Third Plenum of the 18th CPC, President Xi Jinping unveiled an impressive list of proposed economic reforms. The fundamental goal, in his words, was for China to become an innovative society and a “knowledge economy.” Indeed, that similar goal is echoed as one of the key objectives at this Boao Forum, namely: Revolutionary Innovations.” I will speak to that objective.
Allow me to begin with a bit of the history. As many of the delegates here are aware, it was precisely thirty years ago, in 1985, that President Li Xiannian became the first Chinese Head of State to visit the United States. After meeting with U.S. President Ronald Reagan in Washington D.C., he came directly to Chicago to visit with me at the Chicago Mercantile Exchange, the CME Group---today, the largest futures market in the world. With benefit of hindsight, I believe President Li’s visit to the CME---the capital of risk management and foremost champion of innovation---was to tell the world that China was preparing to turn toward a new economic order. Indeed, Mr. Li’s visit to Chicago can be viewed as a prelude to the new economic blueprint subsequently fostered by Deng Xiaoping--- A blueprint which has brought China overwhelming economic success.
My meeting with Li Xiannian, created for me a life’s ambition: Not only would I promote the development of futures markets in China, but would do so throughout the world. I knew that this mission would be of long duration. However, in the long run I knew it would serve the best interests of the CME as well as the real economy of every nation. Over the years, I have advised financial markets in Brazil, France, Germany, Great Britain, India, Israel, Japan, Kuala Lumpur, Mexico, Russia, Singapore, South Korea, Taiwan, and even Ukraine. I knew that the greatest benefit from futures and derivatives markets will flow to economies of these nations. Like Deng Xiaoping’s white cats and black cats, futures markets will direct “market cats” to allocate capital efficiently. They will create an apparatus for price discovery. They will act as a gigantic insurance mechanism to allow inherent market business risks---in agriculture, foreign exchange, interest rates, and equities---to be hedged or adjusted quickly, efficiently, and at lower cost. If you will, they will represent a revolutionary innovation.
In the ensuing years, we maintained a strong connection with Chinese leadership and Chinese futures markets. During the 1990s, we advocated doing away with the multitude of would-be futures markets that were little more than gambling dens rather than servants of price discovery for the economy. What resulted were the regulated futures markets at the Shanghai Futures Exchange, the Zhengzhou Commodity Exchange, and the Dalian Commodity Exchange. The CME maintained strong Memoranda of Understanding with them and all Chinese exchanges, including the Shanghai Gold Exchange, the Chinese Financial Futures Exchange, and the Shanghai Clearing House. These MOUs were initiated to create a forum for education and information-sharing between the exchanges. We provided workshops and symposia. We instituted a continuous visitation program between CME and Chinese exchange officials and employees. We have no doubt that our advice and expertise was extremely valuable. Today, these Chinese exchanges are strong, well run, and capable futures markets.
When in China, I often paid my respects to Vice Premier Wang Qishan. In 2006, as a result of our discussions and with advice from the noted economist Cheng Siwei, we gained approval from the State Council and the CSRC, to create the Chinese Financial Futures Exchange (CFFEX) for trading the CSI 300---the first financial futures exchange in China. I was personally honored with an appointment to the International Advisory Council of the China Securities Regulatory Commission, the CSRC. Today, CFFEX represents one of the most successful futures exchanges in the world. In 2014 we hosted a visit for former Vice Premier, Zeng Peiyan and former Ambassador Zhou Wenzhong. Several months ago we were honored with a visit by Vice Premier Wang Yang who personally spent time with our agricultural traders. Most important, we have maintained a close friendship and dialogue with the CSRC, and its chairman Xiao Gang and vice chairman Jiang Yang.
Our mission is no secret and its results are no mystery. Clearly, our international efforts helped make the CME stronger, but they equally made stronger the foreign economies involved. Allow me to underscore one unique characteristic of our mission that differentiates the CME from other futures exchanges. We have no ambition to take away market share from foreign exchanges. Quite to the contrary. Our mission is to collaborate and partner with foreign markets. It is a win-win, strategy and a CME tradition. We actually helped the creation of the LIFFE exchange in London back in 1981, the SIMEX of Singapore in1984, and the Japanese Exchange in Osaka in1986. This tradition continued to this very day. We are particularly proud of the collaboration between the CME and the BVM&F in Brazil in which we have exchanged a mutual 5% of ownership. Together we have built a joint technology and run order routing systems between our respective trading platforms. We host the Malaysian derivatives exchange, the Dubai Mercantile exchange in which we own 50%, the Minneapolis Grain Exchange, and the overnight Korean, KRX, futures marketplace. We have order routing and other forms of partnership with the Mexican and Singapore exchanges, and we have cross-listing or product collaboration agreements in Japan, South Africa and India. Allow me to emphasize, our purpose and motivation for collaboration and partnership is no different in China. Simply stated, we want to grow together.
Over the years, financial futures became one of the world’s most important instruments of finance. In 2014, the notional value of 2014 financial futures and options volume was an astounding one quadrillion, 936 trillion, 468 billion, and 80 million US dollars, ($1,936,468.80 billion USD) – as reported by the Bank for International Settlements (BIS). In other words, today, years after the 2008 meltdown, derivatives in OTC venues and those on regulated futures exchanges continue to be used by the largest and most sophisticated financial institutions in the world—domestic and international banks, public and private pension funds, investment companies, mutual funds, hedge funds, energy providers, asset and liability managers, mortgage companies, swap dealers, and insurance companies.
Financial entities that face foreign exchange, energy, agricultural, or environmental exposure use the markets to hedge or manage their price risk. Financial intermediaries that have exposure in equities use our markets to hedge or to benchmark their investment performance. Financial institutions that have interest rate exposure from lending and borrowing activities, or their dealing in over-the-counter interest rate instruments, swaps and structured derivatives products, or their proprietary trading activities use our markets to hedge or arbitrage their exposure in money market swaps or to convert their interest rate exposure from a fixed rate to a floating rate or vice versa. About 83% of companies that use derivatives do so to curb the risk of foreign currencies, 76% of firms use derivatives to hedge against changes in interest rates, 56% seek to protect themselves against commodity-price fluctuations, and 34% use derivatives that are based on equity, or stock, markets.
It goes without saying; Chinese futures and derivatives markets have done very well. From exclusive beginnings in agricultural products, they have expanded their reach into finance, metals, and energy. This expansion is to be applauded. However, at last year’s Boao Forum, I pointed out that Chinese futures exchanges are still nearly completely domestic. They are insulated from world participation or international competition. More than 80% volume is from retail participation and dominated by speculation. I suggested that it was now imperative for China to be more open to international investors. As the world’s largest importer of many commodities, Chinese futures markets should be playing a major role in global price discovery. I cautioned that until Chinese future markets become subject to cross-border interaction, the full value of the Chinese futures to the Chinese economy will continue to be limited.
Your leaders understand this. President Xi Jinping said as much when he stated “Let the market play a decisive role.” And Premier Li Keqiang’s remarks at the DAVOS conference reaffirmed China’s commitment to deepen reforms, innovations and deregulation. “We need to say “no” to the traditional mindset,” he said. “We must encourage innovative institutions and press ahead with structural reforms.” It cannot be said any clearer than that.
Further, this direction is evident by the proactive measures taken by Governor Zhou Xiaochuan of the PBOC to internationalize the RMB and advance liberalization of interest rates on bank deposits. It is evident in the creation of the Shanghai Free Trade Zone. It is evident from last year’s approval by CSRC chairman Xiao Gang to allow data transmission of some of Chinese futures products through Globex, the CME’s international network that covers 150 different countries.
And it became abundantly evident when very recently the CSRC chairman issued a Consultation Paper on “Interim Measures on the Administration of Overseas Trading Participants’ and Overseas Brokers’ Engagement in Trading of Domestic Specific Futures Products.” That long title represents a giant step toward creating the rules for foreign proprietary traders and foreign brokers to engage in the trading of selected domestic Chinese futures products. It is a most significant step toward the internationalization of Chinese futures markets. Although I am fully aware that it is but an early step in the long journey on behalf of globalization of China’s markets, it is one China must make.
The CME and I were very pleased with the opportunity to offer our comments on the proposed CSRC Interim Measures. We commend the CSRC for requesting this consultation. The rules are intended to open and increase international participation in the trading of specified types of futures products listed on China’s futures exchanges. In doing so, not only will it begin to open Chinese futures to global participation, it will strengthen the domestic markets, deepen the liquidity of underlying cash markets, and enhance the price discovery process of China’s commodity products. Chinese commodity producers and consumers, investors and traders will be able to better manage price risks and the Chinese real economy will benefit.
We took the CSRC’s request for comment most seriously. We created a designated team of CME market experts and lawyers who are very familiar with CSRC rules and the requirements of US Commodity Futures Trading Commission, the CFTC. I personally met with CFTC chairman Timothy Massad to discuss our response. Thus, we trust our comments will be of great value to the CSRC. Our ultimate goal is mutual---to help establish rules and measures that effectively balance the need for proper regulatory oversight with enhanced access by overseas participants to China’s futures markets.
Accordingly, I am here to offer my congratulations to Xiao Gang and the CSRC in reaching this juncture in the journey toward cross-border trading in futures. It shall start with China’s first international energy futures market. While this is but the beginning, and while there will still be some heavy lifting in the days ahead, you have reached an historical milestone in the life of Chinese futures markets. As one of your wise philosophers ages ago told us, a long journey begins with the first step. It is thus a moment to celebrate. I am proud of my personal contributions and that of the CME and its management. I am equally proud of the contributions made by the chairmen and officials of the Chinese futures exchanges. They built the marketplaces and made them ready for cross border participation.
I trust that my commitment which began with the visit by President Li Xiannian, will result in a permanent partnership between the CME and the Chinese futures exchanges as it has around the globe.
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