China is extending its control of onshore markets to commodities exchanges, spooked by signs that speculators have shifted from China's volatile stock markets to commodities futures.

The country's top commodities exchanges - the Dalian Commodity Exchange (DCE), Shanghai Futures Exchange (SHFE) and Zhengzhou Commodity Exchange (ZCE) - were asked recently by China's exchange regulator to draft rules designed to "regulate the behaviour of program trading" in futures markets, according to people familiar with the matter.

The move comes on the back of a slew of new regulations aimed at curbing what Chinese authorities call "malicious" trading in stock futures, blamed in part for stoking the turmoil that saw stocks slide over 40 percent since June.

That prompted hedge funds and other investors to steer their order flow into commodities, which had previously not been impacted by Beijing's regulatory overhaul.

But after trading volumes in commodities futures such as iron ore jumped sharply last week - just as new stock trading rules kicked in - Beijing appears concerned about the potential for the flow of orders to overwhelm the country's commodities futures markets, which rank second in the world behind the United States in terms of traded volume on the top three commodity bourses.

TARGETING THE AUTOBOTS

A draft of the regulatory changes considered by the Dalian Commodity Exchange, and circulated to a select group of members for feedback, focuses on tightening controls on program or automated trading.

Anyone placing more than 4,000 trades per day based on more than five instances of five orders per second will be considered a program trader.

Traders would be required to provide details of the identity of those conducting program trading, and where they get their funding. Details on program trading strategies and the location of trading servers would also have to be provided to the exchanges. Failure to do this could lead to yet-to-be-defined disciplinary action.

Traders who submit but then withdraw within a second before execution more than 60 percent of the more than 4,000 placed orders on the exchange's order-entry platforms will also trigger increased regulatory oversight.

And traders would be restricted to placing no more than 4,000 trades if they execute orders for more than two futures products, or buy and sell orders of the same product in different futures contract months within one second.

"This is at a preliminary stage and the exchanges are still working on details," said one individual with direct knowledge of the matter. The DCE, SHFE and ZCE were not immediately available for comment.

LIMITING ARB-ING

Locally-registered traders and brokers active in China's commodities markets say the new rules would likely "force out" some firms that specialise in arbitrage trading strategies aimed at exploiting short-term price differences for the same commodity in different months, or different commodities within the same contract month.

One broker said "more than half" of his firm's positions on the SHFE involved buying and selling in different months, and so would be impacted if these new proposals came into effect.

Other sources downplayed the likely impact of the proposals, noting that program trading makes up only a small portion of China's commodity markets.

"Computer-driven program trading is not widely used in commodity trading, and I think the exchange (will adopt these rules) just in case and is being over-cautious," said a fund manager who trades commodities and other assets.

A fund trader in Shanghai said the measures could slow down funds that exited from stock futures and plan to enter commodities.