UBS SDIC fund to conduct arbitrage of commodity futures

China has approved the country's first fund to conduct commodity futures arbitrage trading, which analysts said could bring maturity and stability to the country's volatile commodity futures market.

UBS SDIC, a fund management joint venture between UBS AG and the parent of the State Development & Investment Corp (SDIC), will be able to arbitrage commodity futures through a managed account product.

The product is likely to be sold to high net worth, or wealthy, individuals. SDIC is a State-owned investment company.

Unlike the nation's stock market, most participants in China's commodity futures market are speculators and industry hedgers, with few professional institutional investors such as investment funds.

Domination by speculators has led to intense volatility and prompted regulators to worry about threats to financial stability. Regulators pursued a nationwide clampdown on speculation in the futures market last year.

The approval of the new venture, said Nicholas Zhu, a commodity analyst with Australia and New Zealand Banking Group Ltd, was regulators' latest attempt to improve market stability by bringing in more institutional investors.

"It's a trend that the commodity market will be more and more institutionalized, just like what happened in the stock market," he said.

To keep out individual investors who are prone to speculation, commodity exchanges have been increasing the lot sizes for futures contracts, which raises a barrier to entry.

The Zhengzhou Commodity Exchange, for example, last month raised the size of a lot for two wheat contracts to 50 tons from 10 tons previously.

The regulators' latest move might also draw larger investment inflows into China's commodity markets, which offer trading in futures contracts including copper, gold and soybeans on three exchanges in Shanghai, Dalian and Zhengzhou.

Data from the China Futures Association show that the trading volume of all commodity futures tumbled 34 percent to 1 trillion lots last year as the government clamped down on speculation.

The nation's commodity futures market has "huge" room for arbitrage, said Zhu, created by changing government policies and ever-increasing types of contracts.

He Xiang, deputy director of UBS SDIC's business development department, said in an e-mailed news release that arbitrage opportunities were becoming more common in the commodity futures market, which has a low correlation with other capital markets.

This year, about a dozen new contracts are likely to be launched. The Shanghai Futures Exchange is expected to launch the nation's first silver futures contract.

The Dalian Commodity Exchange plans to launch iron ore futures, while the Zhengzhou Commodity Exchange will offer silk contracts.

"UBS SDIC's managed account product will be a hit. It has the potential to achieve much higher returns than financial futures arbitrage funds," said Zhu.