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China funds, brokerages embrace commodity futures as rules relax

* Two Chinese fund houses launch commods-focused funds

* 16 brokerages apply to set up asset management license

* Domestic funds pave way for opening up to foreign capital

* Market likely to see large inflow of capital

By Samuel Shen and Fayen Wong

SHANGHAI, Oct 11 (Reuters) - Two Chinese fund houses have launched funds focused on the domestic commodities futures market as they look to tap into the burgeoning market that regulators have cautiously opened to local financial institutions this year.

More than a dozen Chinese futures brokerages, which until recently were barred from investing directly into the futures market, have also applied to set up funds that trade commodity futures through a managed account product.

Their entry marks a significant change in the commodities futures market in China, paving the way for the opening up to foreign investors and a large inflow of capital.

"One of the pre-requisites for the opening up of commodities futures to foreign capital is for the market to establish a certain level of maturity and stability. So the move to let domestic funds in is a step forward in that direction," said Ye Yugang, an analyst at Jinrui Futures.

"But the opening up to foreign capital will come in tandem with the liberalisation of the yuan ... so it is possible that they experiment with having some foreign funds in by giving them a yuan investment quota for the commodities futures market."

China, which has for years set strict curbs to keep financial institutions and foreign capital from direct participation in the sector, allowed Qualified Foreign Institutional Investors (QFII) to invest in domestic stock index futures last year.

While China's futures industry may be only 18 years old, its commodities exchanges in Shanghai, Dalian and Zhengzhou are now among the most liquid in the world.

Last year, the Shanghai futures exchange was the 12th-largest derivative exchange in the world by volume, according to the Futures Industry Association, and the Zhengzhou and Dalian exchanges were just behind it.

Only five percent of investors in China's commodity futures markets are direct producers and consumers, while the rest are private investors, the head of the Dalian Commodity Exchange has said.

The domination by speculators has led to large swings in price and volumes, sparking concerns about threats to financial stability. A clampdown on speculative trading last year saw total trading volumes of commodities futures drop 34 percent to 1 trillion lots, data from the China Futures Association showed.

LARGE CAPITAL INFLOW

Authorities would now like to see the share of hedgers and professional traders increase to curb the volume swings. That is one reason the China Securities and Regulatory Commission (CSRC) requires the managed funds to target only high net-worth individuals.

"If more sophisticated institutions participate in this market, there would be increased liquidity and stability," said Gilbert Tse, executive vice general manager of Fortune SG Fund Management Co.

Globally, commodity trading funds have jumped sevenfold over the past decade to around $315 billion, underscoring the potential in China, Fortune SG said.

Fortune SG is partly owned by Societe Generale . It has launched China's second commodities futures investment fund in partnership with British hedge fund manager Winton Capital.

A joint venture between UBS AG and the parent of the State Development & Investment Corp was the first fund to be approved to trade commodity futures in June.

Tse said he believed futures funds would become popular in the long term as they could help improve Chinese investors' asset allocation and expand their investment channels.

The business could also create a new revenue stream for China's futures brokerages, many of which are battling fierce competition.

Sixteen futures brokerages, including Yongan Futures, Zheshang Futures and China International Futures Co have also applied to start fund businesses, according the CSRC.

"If the stock market keeps falling, alternative investments, including futures-related products, will become more popular," said Li Yin, analyst at fund consultancy Howbuy.

(Editing by Clarence Fernandez)

((samuel.shen@thomsonreuters.com)(+86 21 6104 1789)(Reuters Messaging: samuel.shen.thomsonreuters.com@reuters.net))

Keywords: CHINA FUTURESFUND/