Derivatives trading growing in Asia

Russell Beattie August 23, 2022 08:52

As investors in Asia become more active, both individuals and institutions are increasingly turning to futures and options to manage risk. Factors such as high inflation, the war in Ukraine and continuing fallout from the pandemic are exerting upward pressure on agriculture and energy prices, and stock markets around the world are experiencing significant swings.

Meanwhile, interest rate hikes made by the Federal Reserve (Fed) have led to a strengthening U.S. dollar, putting pressure on emerging market economies, and increasing currency risks. Against this backdrop of market uncertainty, the benefits of hedging are clear.

Derivatives trading volumes in Asia have been on a strong upward trend in recent years, driven by a combination of market infrastructure and development, strong regulatory frameworks, and increased understanding among both institutions and sophisticated retail investors of the benefits futures and options can offer.

In fact, trading in futures and options in the Asia-Pacific region soared by 61.4% year-on-year in the first five months of 2022, accounting for more than half of all contracts traded globally, according to figures from the Futures Industry Association. Within this total, there was a significant increase in equities futures and options trading, with the region accounting for more than half of global contracts in this area. By contrast, there was a fall in demand for commodities futures and options, largely driven by China. This is likely a result of the ongoing uncertainty created by COVID-19 lockdowns and their ongoing impact on economic activity.

In a further sign that Asian investors are becoming more market-sophisticated, there was also a gradual rise in open interest – the number of outstanding contracts not yet settled – in the region during the first quarter of 2022. Although Asia-Pacific continues to lag North America, Europe and Latin America in this area, the trend suggests the size of the markets in Asia is growing.

Meanwhile, currency volatility has led to a surge in foreign exchange hedging in the region. CME Group’s FX volumes in the Asia-Pacific region increased by close to 15% year-on-year in the first six months of 2022.

Alongside growing demand from investors, derivatives markets in Asia are continuing to develop, particularly in China. China has five domestic derivatives exchanges, three of which were ranked in the top 10 globally in terms of the volume of trades in 2021, with products covering commodities, bonds and equities available.

Trading reached record volumes in 2021, with more than 7.5 billion contracts worth RMB 581.2 trillion changing hands during the year, according to the China Futures Association. China has become the leading global futures market for agricultural, non-ferrous metals and coal products, while it continues to develop benchmarks for the region, particularly in metals, agriculture and, to a lesser extent, energy.

Regulatory developments are also continuing to support the market. The new Futures and Derivatives Law, which has been adopted by the National People’s Congress and came into effect on Aug. 1, 2022. It sets out a comprehensive legal framework for the trading, marking a significant step in enhancing the market infrastructure.

All futures and derivatives exchanges will require regulatory clearance to operate, while financial institutions will require approval for trading in derivatives other than futures. Another significant development is that the law marks the first time that close-out netting will be enforceable under legislation. It also sets out rules covering insider trading, as well as market manipulation and other activities that could distort futures and derivatives markets.

The new law is expected to increase international participation in China’s derivatives market. It follows changes to the Qualified Foreign Institutional Investor program made at the end of 2021 to allow foreign investors to trade commodity futures and options and stock index options.

Meanwhile, product choice in China is continuing to expand，with the introduction of new contracts such as iron ore futures and container freight futures. Plans are also under way for a Chinese domestic exchange to launch industrial silicon contracts. At the same time, researchers at the People’s Bank of China issued a working paper last year calling for a yuan futures market to be developed in the country to enable investors to hedge against foreign exchange risk.

With global price volatility looks set to continue, futures and options remain an important risk management tool. As Asian investors become increasingly comfortable with derivatives, regulation is strengthened and new products are launched, the current trends of increased interest and trading could continue.

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Russell Beattie

Managing Director and Head of Asia Pacific of CME Group