Before the ban, futures brokers were launching hundreds of structured products a month offering guaranteed returns, which attracted institutional cash and fed billions of dollars into the commodity futures markets.
Now, fresh launches are just a trickle as the brokers comply with new rules that include a ban on guaranteed returns. With no promise of big returns, the 100 brokers or so that run asset management businesses offering these products are struggling to keep clients.
“The new rules made the launch of structured products nearly impossible,” said Ni Chengqun, a senior manager with the asset management arm of Hicend Futures in Shanghai.
The slump in trade is a blow for the likes of the Shanghai Futures Exchange and the Dalian Commodity Exchange, which run China’s biggest commodity futures contracts.
Average daily volume in steel rebar futures, for example, dropped to 5.3 million in September from 13.5 million in April, while iron ore turnover dropped to 1.5 million from 4.7 million.
The rule changes by the Asset Management Association of China (AMAC) prohibit asset managers at futures brokers from guaranteeing returns, restrict leverage and include stricter standards for funds acting as advisors. AMAC was taking aim at highly-leveraged products that were offering the promise in many cases of returns of 8-9%.
In one popular type of product, brokers pooled funds from investors and deployed the capital in equities, fixed income and commodity futures markets for a specified period. An outside fund acted as an advisor to devise the trading strategy.
Futures were central to many of the products because they offer the ability to leverage, one asset manager said, citing the need to deposit as little as 10% of the contract value on margin. So an investor pool of $10m can wield a notional position of up to $100m in the market.
As a result, a relatively modest price gain in that market can produce outsized profits on the initial deposit.
Such juicy returns attracted institutional fund managers. Banks such as China Merchants Bank and some of the big-five lenders flocked to the products, asset managers said.
Big promises, bumper leverage
In the first half of 2015, the hottest structured products were tied to equity indexes like the Shanghai/Shenzhen CSI 300 Index, which surged roughly 50% from January to June amid a retail investor buying frenzy.
Futures on the CSI 300 rallied by the same degree, and volumes more than doubled from the year before to average over 1.2 million contracts a day for the first half of 2015.
Alarmed by the prospect of a bubble, regulators then stepped in to restrict trade, triggering an exodus from stocks and effectively barring retail investors from trading stock futures. CSI 300 futures volumes collapsed. Average trade in the first half of 2016 was 80 times less than a year earlier.
That’s when futures brokers steered investors into fixed income, equities and commodities, sparking a surge in commodities trading in early 2016. Iron ore and steel futures prices jumped more than 60% by mid-April.
Lower fees, more competition
For brokers, the latest rules come just as a proliferation of new rivals has intensified competition in their core business of hedging risk.
An estimated 80% of brokers’ asset management business focused on leveraged structured products, people working in the sector said.
Now, brokers like Huatai Futures, which manages more than 10bn yuan ($1.5bn) in assets, and Hicend Futures, are finding only tepid interest from investors in products that comply with the new rules.