January 16, 2015

The Regulations on the Administration of Trading in Bulk Commodities on Spot Markets in the China (Shanghai) Pilot Free Trade Zone (hereinafter the “Regulations”) jointly formulated by the Management Committee of the China (Shanghai) Pilot Free Trade Zone (the “the Management Committee”), the Shanghai Municipal Commission of Commerce and the Shanghai Financial Services Office captured extensive attention after the draft for public commentary was modified and officially unveiled on November 17. W&B’s lawyers were honored to be engaged by the Management Committee to provide legal services for the formulation of the Regulations. 

As one of the world’s major importers of bulk raw materials, agricultural products and energy, China is striving to stay in the upstream industry chain; in particular, winning pricing power is of critical importance for the stable economic development of the country. Promoting the construction of the bulk commodity trading market, coordinating the “two markets and two resources” of the country and the world at large, further facilitating investment and trading, and promoting cross-border use of the RMB are strategically significant for amplifying the resource allocation function of bulk commodities, enhancing China’s competitiveness and clout in bulk commodity trading, and pushing forward Shanghai’s “four centers” development. To this end, the State Council approved the Framework Plan for the China (Shanghai) Pilot Free Trade Zone, which proposes the construction of international bulk commodities markets and “the exploration of the establishment of an international commodity trading and resource allocation platform in the FTZ as well as the international trading of energy products, basic industrial raw materials and agricultural commodities”.

The Regulations are designed to govern the operational rules of bulk commodities markets in the FTZ. They represent the latest development of the FTZ’s efforts to further deepen the development of bulk commodities markets as well as the administrative authorities’ useful efforts to perform supervision and management both during and after events. The Regulations outline many innovative ideas and highlights, and exert a profound influence.

Highlight 1: Developing Bonded Transactions
The Regulations stipulate that bulk bonded physical goods and corresponding ownership certificates are objects of bulk commodities spot market trading. This provision is helpful in taking full advantage of the FTZ’s preferential tax policy of “inside the territory, outside of Customs”. The FTZ will also provide well-developed bonded goods logistics services and efficient and rigorous Customs supervision for bulk commodities transactions, thereby encouraging strong enterprises from home and abroad to participate in bulk commodities spot trading, upgrading average transaction size and market operational efficiency, and better serving the real economy through spot markets.

Highlight 2: Using the RMB for Quotation and Settlement
The Regulations give full play to the financial policy of opening an FT account in the FTZ. The use of the RMB for quotation and settlement, as prescribed in the Regulations, is helpful for promoting the RMB’s globalization, thereby demonstrating China’s power in the pricing of bulk commodities in the international arena. The Regulations have received active support from relevant finance regulatory bureaus.

Highlight 3: Separating Transactions, Custody, Settlement and Warehousing
The Regulations for the first time provide a detailed implementation plan for the separation of transactions, custody, settlement and warehousing for the bulk commodities spot markets. This plan can effectively avoid the absence of internal supervision that is likely caused by the overly consolidated functions of the markets, by specifying that a third-party clearing agency must conduct consolidated clearing of the trading funds of the markets in order to ensure that the settlement of funds is safe and independent. Entrusting a commercial bank for fund deposits while the clients’ trading funds are deposited in a special capital account can minimize the risk of embezzlement, misappropriation and even abscondment that might be caused by the market’s direct involvement in the management of trading funds. 

Highlight 4: Introducing Third-Party Warehouse Warrant Publicity Agencies
The Regulations not only separate transactions from warehousing, but also introduce third-party warehouse warrant publicity agencies in an attempt to minimize, via modern technology, the risk of the loss of goods, fake warehouse warrants and re-pledge of the same warrant. They do this by instituting a variety of measures including publicizing warehouse warrants, data cross-checking, random inspections and verification, and supervision of physical commodities. The Regulations also contain a series of provisions on matters including warehouse performance guarantee oppositions, disputed warehouse warrant risk alerts, and graded security systems for warehouses for delivery and receipt, to ensure that third-party warehouse warrant publicity agencies can function effectively. 

Highlight 5: Establishing a “3+1” information Cross-Checking System
According to the Regulations, a “3+1” information cross-checking system will be established via a third-party warehouse warrant publicity agency platform. This means that transactional information, settlement information and warehousing information will be subject to real-time cross-checking through the interconnection of information systems of trading markets, third-party settlement agencies and warehouses. In addition, a regular quantity comparison using the Customs’ bonded commodities supervisory information and the warehouse warrant information from the warehouse warrant publicity agencies will be conducted to verify that information on transactions, funds and commodities is consistent, thereby minimizing underlying ethical risks during events. 

Highlight 6: Guiding the Development of Effective Risk Management Mechanisms
The Regulations provide guidance for establishing effective risk management mechanisms including a multi-faceted “risk firewall” consisting the trader contract performance guarantees, warehouse risk guarantees and market risk reserve funds established to minimize risks, avoid domino effects and enhance the stable operation of bulk commodities spot markets within the FTZ. In respect of duty allocation, the Regulations stipulate that the relevant market parties must clearly define their rights and obligations through prior negotiations and adequate communications via bilateral or multi-lateral agreements, so as to avoid the “buck-passing”. 

Highlight 7: Increased Market Operational Transparency
The Regulations fully demonstrate FTZ innovations in its regulative functions by introducing enterprise information dissemination systems, replacing the practice of market operators filing with government bureaus for record with active information disclosure, and guiding and encouraging various social actors to take part in market supervision. This not only helps alleviate the government bureaus’ supervisory burdens and advance the transformation of administrative functions, it also increases the efficiency of supervision efforts and reduces risks caused by false information reporting by enterprises. The Regulations also simplify information reporting formalities for enterprise information dissemination systems, thereby enhancing information sharing between bureaus.

In addition, since in the past markets frequently revised their “trading rules” to evade responsibility or even abuse their power for personal gain, the Regulations demand that markets solicit opinions publicly when formulating or revising trading rules, and must undertake reasonable transitional measures to fully secure the traders’ legal rights and interests.

Please note that the Interim Provisions on the Administration of Bulk Commodities Spot Market Trading in the China (Shanghai) Pilot Free Trade Zone are currently being revised. It is expected that duty allocation and cooperation between relevant regulatory bureaus will be further specified.