China commodities regulation: time to end the turf war

Oil futures traders in China are not very happy. Shoddy regulation has just cost the sector an estimated $1 billion – and Bank of China, the broker at the heart of this loss, has been slow to admit responsibility. This does not bode well for a country that wants to play a broader role in global price discovery.

The losses occurred in mid-April, when, for the first time ever, US oil futures prices strayed into negative territory. Rather than roll its oil contracts – most of which were held by retail investors – over to the next month, a sizeable number appear to have been settled during the period when oil prices remained at these historically low levels.

This raises some obvious questions about China’s internal risk management procedures – in many other markets, these contracts would have habitually been rolled up to a week before the expiration date. But it also highlights important concerns about the mishmash of regulations that still govern China’s financial industry.

While Bank of China is regulated by the China Banking and Insurance Regulatory Commission (CBIRC), most of China’s derivatives expertise – including within the field of commodities – still resides within the China Securities Regulatory Commission (CSRC).

What does the banking regulator know about the commodities market?

Futures trader

As one disgruntled futures trader puts it: “What does the banking regulator know about the commodities market?”

The CBIRC was formed in 2018 out of a merger between the banking and insurance regulators, in order to promote better risk management oversight of the banking and insurance sectors. At the time, there was some discussion about also incorporating the CSRC into this single markets watchdog, but the markets were considered too different to make this immediately practical. Now is the time to resurrect this debate.

Fraud scandal

The merger of the banking and insurance regulators came close on the heels of a scandal involving the chairman of Anbang Insurance, who was being investigated at the time for – and subsequently found guilty of – fraudulently raising money from investors.

By the time the Anbang scandal broke, the chairman of the insurance regulator had already been dismissed for abuse of power and failing to properly monitor risk in the sector. This made it a lot easier for the regulators to unite under a single banner. The head of the banking regulator – Guo Shuqing, a prominent figure within Chinese financial markets reform, and also vice-governor of the country’s central bank – took over the running of the merged entity.

Bringing the CSRC into the mix could be trickier, and its chairman, Yi Huiman, is likely to resist any pressure to cede his authority to a separate unit. But, as the failings at Bank of China show, this is clearly a debate that needs to be had: how can the CBIRC leverage off the expertise of the CSRC to provide more robust oversight of Chinese financial markets?

This is even more important given the pace at which China is trying to open its financial markets. In 2018, the CSRC approved the launch of the Shanghai International Energy Exchange’s crude oil contract. Although participation in the contract has been slow, the hope is that allowing foreigners to play in the onshore oil market will help bring price discovery onshore. That’s not going to happen if China’s watchdogs can’t demonstrate effective oversight of the market.

And it’s not just the commodities markets that the banking regulator needs to gain a proper understanding of. In February, domestic banks won approval to start trading bond futures – they had been shut out of the market following a trading scandal in the 1990s. But, again, much of the expertise for policing derivatives in the fixed income markets resides with the CSRC: the CBIRC simply hasn’t had to get involved.

For the sanctity of Chinese financial markets, this regulatory turf war needs to end.