China is still the place to be…

Coming from an institutional background has advantages when working in the retail industry. But in the case of China, it can also present challenges.

One of the fascinating things about the Forex market in China is that it’s almost entirely retail based. The market there has been built from the ground up in a retail framework to become the largest source of retail investment in the world – and by some margin.

However, many participants cannot see the forest from the trees when it comes to the regulation that is sweeping through the country.

It began in earnest with the push for inclusion in the MSCI World Index some 5 years ago, resulting in the granting of 234 individual A-share stocks on June 1. This represented a 0.39 per cent weighting in the Index with further inclusions in the September quarter and plans to grow the representation to 5 per cent in the future.

Charts MSCI EM Index chart outlines composition of MSCI under these guidelines. Source: MSCI.

This complemented the very strategic move with the Hong Kong – Shanghai – Shenzhen connect, a function whereby global houses can trade mainland stocks via the already well-established Hong Kong exchange.

Whilst short selling in most names is still restricted, it won’t be long until the market is fully functioning and has many more participants.

The Chinese regulations around broking houses in the mainland are also being reformed. From 2020 fully foreign-owned brokers will be allowed to exist, a departure from the 51 per cent China-owned joint venture status that is currently in operation.

From 2021 further reforms to investable asset classes for foreign firms are being introduced, meaning offshore capital will be flowing into mainland China at a faster rate than ever before.

What does this have to do with Forex I hear you say? Well, currently Forex brokers exist in the grey area of Chinese law, where it is neither illegal nor legal to operate. But recent changes on the ground in China suggest that the Forex industry is being groomed towards regulation in order to legitimise the market, which accounts for a huge amount of domestic interest.

The Average Daily Volume Chart represents 2017 daily forex volumes. All these brokers have exposure to China:

As is always the case in life, if you do the right thing you tend to avoid trouble. This is the case with much of the Forex industry in China, however, there are always a few bad eggs. In recent times many poorly behaved brokers in both the commodity and Forex space have been removed from the industry by authorities.

The merchant space has also been cleaned up and with the introduction of a centralised China Union Pay clearing system. This will continue the push towards best practice in the industry.

All these things are very positive for the Forex market in China and Australian brokers are set to be some of the biggest beneficiaries of new accounts and capital deposits. Recent changes by the FCA have left many European brokers with lower levels of leverage to trade.

This has seen an influx of new accounts to AFSL holders who can still offer higher leverage to clients, and in China most clients want the ability to trade bigger.

Explaining these reforms to clients and staff in China hasn’t been without issue though. Many players cannot imagine the more open and regulated market we are moving towards. This is based on a historical view of the market, which has traditionally been fearful of authority.

It’s often the way in China, where short-term gain is prized over long-term business establishment in the Forex space. An over-riding notion of ‘make as much money as quickly as possible’ is often the mindset of too many participants.

This could change though, as China’s efforts to bring more people into the middle class leads to an increase in retail traders throughout the country. Whilst many believe the market is already saturated with brokers, the swell of wealth and people with capital to deploy into trading is only just beginning in mainland China.

A good illustration of this shift is the property market, where 2nd and 3rd tier cities that are newly built are seeing price increases that are outpacing 1st tier ones.

Chart 1: 2nd & 3rd tier cities (orange and yellow) outpacing 1st tier cities (white). Source: Bloomberg.

Chart 2: 2nd tier city prices outpacing 1st tier city prices. Source: Bloomberg.

What remains to be seen is if this will lead to deregulation in the Institutional space and specifically the free-floating of the Yuan. It is well known that China likes to control its currency and I cannot see that changing short term. But what it would do is propagate more institutional trading of the Yuan- thus leading to more international acceptance, which would result in further investment in the mainland.

One thing sure to be of focus in a conversation about that is liquidity, and as illustrated in the Liquid Currency Pairs Chart, the Yuan doesn’t feature in the most liquid currency pairs of 2018.

Financial Markets professional with 20+ years’ experience across interest rates, foreign exchange, commodities, indices and equities. He is the General Manager of Sydney-Shanghai Synergy Financial Markets. 

Matt Starkey is General Manager of Sales and Trading at Synergy Financial Markets.

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