Opening China's stock index futures market to institutional investors is a necessary step for the market to develop to its full potential with arbitrage activity developing quickly as the trading volume increases, said a senior executive of Chicago Mercantile Exchange (CME) Group.

John W. Labuszewski, managing director of research and product development at CME Group, said the move "was a very favorable indication that the regulations were opening up and allowing institutions to participate in the market".

"It will be critical to the future growth and the success of the product," he added.

Index futures contracts have been traded actively since their debut in Shanghai on April 16. But analysts said the current high turnover rate and small holding size indicated that the market was dominated by retail investors.

China's securities regulator last week allowed brokerages and mutual funds to take part in the new financial derivative with certain restrictions.

It stipulated that funds and brokerages can only use the instrument for hedging purposes and capped long futures positions at 10 percent of net assets and short positions at 20 percent of stock holdings.

"Based on the initial week's trading volume, it certainly appears that the Chinese market adapted extraordinarily quickly to embrace new opportunities," Labuszewski said.

Market watchers said the newly launched financial instrument is likely to provide a boost for China's fund industry by fostering new investment products and spawning new investment strategies by institutional investors.

Foreign institutions are also keen to participate in index futures trading under the Qualified Foreign Institutional Investors (QFII) program and are waiting for the regulator to clarify the relevant rules for QFII investors.

"Index futures have not been able to play their full role in price discovery and risk management in the initial trading as the market is dominated by small investors," said Walter Lin, chief representative of UK-based fund management company Aviva Investors in China.

The UK's largest mutual fund, with about $363 billion assets under management, has recently been granted a quota of US$1 billion to invest in China's capital market.

Lin said the participation of institutional investors and large hedgers is essential for index futures to develop to their full potential and hoped that the regulators could relax the restrictions for QFII investors by capping the value of long holdings of index futures contracts at 50 percent of net assets.

(China Daily April 26, 2010)