A tale of two contracts: Was the SHFE copper futures market disrupted by the listing of INE bonded copper futures?

• Published date: 01 February 2024
• Author: Tao Xiong,Miao Li
• Date: 01 February 2024
• DOI: http://doi.org/10.1002/fut.22473

Received: 12 June 2023

|

Accepted: 16 October 2023

DOI: 10.1002/fut.22473

RESEARCH ARTICLE

A tale of two contracts: Was the SHFE copper futures

market disrupted by the listing of INE bonded copper

futures?

Tao Xiong

1,2

|Miao Li

2

1

School of Agricultural Economics and

Rural Development, Renmin University

of China, Beijing, China

2

College of Economics and Management,

Huazhong Agricultural University,

Wuhan, China

Correspondence

Miao Li, College of Economics and

Management, Huazhong Agricultural

University, Wuhan, China.

Email: miaoli@webmail.hzau.edu.cn

Funding information

National Natural Science Foundation of

China, Grant/Award Number: 72171099;

China Agriculture Research System of

MOF and MARA, Grant/Award Number:

CARS‐23‐F01; Key Project of Philosophy

and Social Sciences Research, Ministry of

Education, Grant/Award Number:

20JZD015; Major Projects of the National

Social Science Foundation of China,

Grant/Award Number: 22&ZD079;

Fundamental Research Funds for the

Central Universities,

Grant/Award Number: 2662022JC001

Abstract

Leveraging tick‐by‐tick data, this study provides the first analysis of Shanghai

International Energy Exchange (INE) bonded copper futures' performance in

market quality and price discovery. In particular, we investigate the effects of

the market opening (listing of INE bonded copper futures) on Shanghai

Futures Exchange (SHFE) copper futures' market quality and price discovery.

Our results show that the market quality and price discovery of INE bonded

copper futures in the first year of the listing is not promising. Our synthetic

control method results suggest that market openness does not significantly

reduce SHFE copper futures' market quality in terms of activity, liquidity, and

volatility. Moreover, market openness does not significantly reduce the SHFE

copper futures' price discovery effectiveness. Overall, the performance of new

INE bonded copper futures needs improvement, while its listing did not

disrupt SHFE copper futures. Our results suggest that a dual‐contract mode is

an alternative option for internationalization in China's commodity futures

markets.

KEYWORDS

copper futures, internationalization, market quality, price discovery, synthetic control

1|INTRODUCTION

After more than three decades of development, Chinese commodity futures markets have undergone remarkable

developments along with the country's rapid economic growth and financial market improvement. Conventionally,

direct participation in foreign investment is prohibited (Fan & Zhang, 2020). In recent years, however, China has

accelerated the process of liberalizing its commodity futures market. On March 26, 2018, crude oil futures were the first

to open to foreign traders in Chinese commodity futures markets.

1

Since then, China has opened iron ore, Purified

Terephthalic Acid (PTA), Technically Specified or Block Rubber 20 (TSR20), low‐sulfur fuel oil, copper, palm oil, No. 1

J Futures Markets. 2024;44:281–301. wileyonlinelibrary.com/journal/fut © 2023 Wiley Periodicals LLC.

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Previous efforts include relaxing eligibility criteria, removing several quantitative requirements—such as the minimum term of operation and size of

assets under management—and allowing a wider range of market participants to apply for a Qualified Foreign Institutional Trader license (Futures

Industry Association [FIA], 2020). Another vital step in accelerating the internationalization process of Chinese commodity futures markets was

opening night trading in 2013.

soybean, No. 2 soybean, soybean oil, and soybean meal futures to foreign traders. As of May 2023, 11 commodity

futures in China allow direct participation from foreign investment,

2

and global traders are becoming increasingly

interested in those markets.

There are three modes by which China's commodity futures markets have opened to foreign traders:

(1) opening to foreign traders after a few years of listing, for example, iron ore, PTA, palm oil, No. 1 soybean,

No. 2 soybean, soybean oil, and soybean meal futures; (2) opening to foreign traders when listed, for example,

crude oil, TSR20, and low‐sulfur fuel oil futures; and (3) dual‐contracts mode, in which other new international

futures are listed for foreign traders and domestic futures remains unchanged. Under the dual‐contracts mode,

the Shanghai International Energy Exchange (INE) launched the new international bonded copper futures for

foreign traders without changing the existing Shanghai Futures Exchange (SHFE) copper futures.

3

Copper is a

vital and fundamental substance for economic and social development and is widely used in many fields, such as

energy, information, and national defense (Li et al., 2017; Sverdrup et al., 2014). China has the largest copper

consumption in the world, but the domestic copper reserves are limited (Kuipers et al., 2018). China has become

the largest copper importer in the world. China's import of copper ore and its concentrate continuously

increased from 6468 thousand tons in 2010 to 23,387 thousand tons in 2021, an increase of approximately 261.5%

(Li et al., 2023). Thus, the listing of INE bonded copper futures has garnered great attention from potential

international traders interested in the Chinese copper market. According to the FIA, INE bonded copper futures'

trading volumes were 4.83 and 5.55 million contracts in 2021 and 2022, respectively. The dual‐contract mode

allowsthepresenceoftwomarkets—one SHFE copper futures market merely for domestic traders and another

INE bonded copper futures market for qualified traders, regardless of whether they are domestic or international

(INE, 2021).

However, as a novel innovation, the dual‐contract mode faces two potential risks. First, considering that

SHFE copper futures already exist, is the performance of INE bonded copper futures acceptable for the regulator

and to domestic and foreign traders? To be clear, how effective are the market quality and price discovery of INE

bonded copper futures? Market quality and price discovery are the keys to realizing the goals of listing INE

bonded futures for boosting China's influence in the global pricing of copper, accelerating RMB international-

ization, and helping build China into an international pricing center for copper. Second, both domestic and

foreign traders might prefer the INE bonded copper futures market, as it is expected to be more connected with

the international market, which might lead to worse market quality and deterioration in the price discovery

function of the existing SHFE copper futures market. In other words, does the market openness (listing INE

bonded copper futures) disrupt the existing SHFE copper futures? The above two questions on China's dual‐

contracts mode are still unanswered.

Thus, we examine the performance of the new INE bonded copper futures market in terms of market quality and

price discovery. Then, we empirically investigate the impacts of market openness in the market quality and discovery of

the existing SHFE copper futures. Leveraging tick‐by‐tick data, specifically, we assess market quality in market activity,

liquidity, and volatility, based on market microstructure theory. We compare the market quality of INE bonded copper

in the first year of listing with SHFE copper futures before and after market openness.

4

In addition, to examining the

pricing power of INE bonded copper futures in international copper markets, we measure the contribution of INE

bonded copper futures to the price discovery process relative to the London Metal Exchange (LME) copper futures. The

market openness (listing INE bonded copper futures) of the copper futures markets is defined as the policy intervention

event. As such, we use the synthetic control method to investigate the impacts of market openness on SHFE copper

futures' market quality. In such causal inference, the treatment group is SHFE copper futures, while the control group

is the unopened commodities futures in China. The market quality of SHFE copper futures is the outcome variable of

interest. Moreover, we also calculate the time‐varying price discovery contribution of the SHFE copper futures relative

2

Other products under discussion include methanol, soybeans, linear low‐density polyethylene, polypropylene (PP), aluminum, nickel, zinc, lead,

and tin. According to the China Securities Regulatory Commission on December 25, 2020, China will take multiple measures to expand the opening

of futures markets.

3

For easy differentiation, we refer to the existing copper futures as SHFE copper futures for domestic traders and the newly introduced copper futures

opened for foreign traders as INE bonded copper futures based on the exchanges on which they are traded

4

Because INE bonded copper futures are the only international futures in China's dual‐contract mode, SHFE copper futures in the pre‐and

postperiods are used for comparison in this study.

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XIONG and LI