By Fayen Wong and Polly Yam
SHANGHAI/HONG KONG, Oct 23 (Reuters) - China will retain a ban on overseas commodity exchanges setting up warehouses there, a government source said, dashing expectations for London Metal Exchange warehouses in the newly launched Shanghai free trade zone.
Although the LME has been cautious about its chances, state-owned local media had reported that the exchange would be allowed to authorise commodity warehouses in the free-trade zone, while warehousing facilities did not appear on a list of banned activities.
Bringing the centuries-old bourse to China was one of the major rationales the Hong Kong stock exchange gave last year for its $2.2 billion acquisition of the LME. Warehouses on the mainland would allow the world's biggest marketplace for industrial metals such as copper and aluminium direct access to the top consumer of those metals.
"Foreign exchanges will not be allowed to have warehouses in the free-trade zone. The current ban will stand," said the source with direct knowledge of the policy.
The ban was issued by the China Securities and Regulatory Commission (CSRC) in 2008.
Although the Shanghai government in its draft proposal sought to have the LME open storage facilities in the zone, the source said the idea ran into strong opposition from the securities regulator.
"The overriding concern is that letting the LME have a mainland presence would pose a serious challenge to the Shanghai Futures Exchange (ShFE)," said the source, who was not authorised to speak to the media.
An official from the CSRC declined to comment, adding that any questions would be answered at a regular press briefing on Friday. An LME spokeswoman said the exchange was not aware of any new developments specifically relating to setting up warehouses in the Shanghai free trade zone.
The ShFE lists futures in copper, aluminium, zinc and lead, placing it in direct competition with the LME for traders looking to hedge against or speculate on price movements for physical metal.
The LME has sought for many years to set up delivery networks in China, a move which would help draw Chinese investors and end-users who would be able to better take advantage of the price arbitrage between the domestic and London markets.
It would also help Chinese manufacturers by cutting logistics fees, a major cost component in the premiums they pay on top of LME contract prices to obtain the metal.
In an acknowledgement of the regulatory hurdles, the LME's new chief executive Garry Jones said last week that its dream of opening metal warehousing facilities in China is some way off.
The free-trade zone has been billed as a watershed for China's development, with Beijing vowing to roll out a range of ambitious reforms including renminbi convertibility within the next three years.
For the commodities markets, the Shanghai government has promised the opening up of its prized futures markets to foreign players and allowing local firms to hedge on overseas bourses.
But the plans announced so far remain skeletal and doubts remain on whether the zone can live up to expectations.
"It seems like there are concerns about control, so there would likely be restrictions on the types of foreign firms who can participate, how much they can invest and how much profit they can take out," said an Shanghai-based executive with a foreign bank involved in policy discussions.
Under the latest rules, the SHFE would be allowed to set up an International Energy Trading Centre in the zone, from which it can open its long-awaited crude oil futures contract and other energy products to qualified foreign investors.
Brokers registered in the zone will also be able to trade on overseas futures exchanges for local clients via the over-the-counter market.
"Plans to allow selected futures brokerages to trade abroad has been in place since 2011 and there has been little progress," said a manager at a local brokerage.
"I think there are some in Beijing's decision body that remain worried about Chinese firms losing out and being easy targets to globally savvy traders and financial institutions."
Some of China's biggest airlines and shipping companies lost hundreds of millions of dollars in 2008 on derivative trades made with international banks when oil prices plunged.