JC Master · Listed Company Securities Compliance Column | Key Considerations in “Indirect” Hedging

　　The high-quality development of the capital market hinges on the compliance foundation of listed companies. As the registration-based system is fully implemented and regulatory frameworks are iteratively refined, securities compliance has become a central pillar for the stable operation of listed offices. Accurately aligning with regulatory guidance and fortifying compliance safeguards are critical enablers for enterprises to navigate market cycles.

　　To this end, we have established this dedicated column, focusing on the core areas of securities compliance for listed companies: summarizing the key points of new regulatory rules, deconstructing the rationale behind typical enforcement actions, dissecting the essence of court rulings, and conducting in-depth analysis of practical compliance challenges. Adopting a legal‑professional perspective, we employ pragmatic language and scenario‑based analysis to clarify compliance requirements, map out risk pathways, and provide actionable guidance, thereby helping companies strengthen their internal control systems, mitigate compliance risks, and enhance the effectiveness of their compliance management.

　　When compliance thrives, enterprises thrive; when compliance is stable, development is stable. We hope this column will serve as a trusted professional partner for listed companies—helping them discern regulatory trends, address compliance challenges, mitigate compliance risks, and strengthen the foundations of sustainable growth—so that together we can foster the sound and healthy development of the capital market.

　　Hedging refers to the practice whereby a company or investor enters into futures contracts on the futures market that are opposite in direction but equal in size to their spot‑market transactions, with the aim of offsetting price fluctuations in the spot market through the hedging effect of these futures contracts.

　　When listed companies engage in hedging activities, the futures and derivative instruments they select are primarily limited to those related to the company’s production and operations, such as products, raw materials, and foreign exchange. In principle, the types, sizes, and maturities of these futures and derivatives should be aligned with the risk exposures that require management.

　　Although the range of futures contracts continues to expand and the market’s structure is becoming increasingly sophisticated, the raw materials used in listed companies’ production and operations have grown more diverse. As a result, certain raw‑material products lack corresponding futures contracts on the exchange, making it difficult to implement effective hedging strategies. Consequently, some listed companies seek to hedge risks associated with upstream key materials that closely track price movements, leveraging price linkages to indirectly offset the operational risks arising from fluctuations in spot prices.

　　Regulations Governing Hedging Activities of Listed Companies

　　To help listed companies manage risks associated with futures investments and to prevent them from engaging primarily in speculative futures and derivatives trading, the exchange has explicitly stipulated that listed companies’ hedging activities involving raw materials must be confined to their core business operations and must effectively offset spot‑market price risks related to the raw materials used in their production and operations. The exchange has also enumerated six categories of such trading activities.

　　“Indirect” Hedging Case

　　The core of hedging lies in risk mitigation; its primary objective is to reduce the impact of price volatility on corporate operations or investments by locking in costs or sales prices, thereby stabilizing production and business activities and enhancing market competitiveness. Hedging of indirect raw materials can benefit the production and operations of listed companies. Based on an examination of market cases, some companies have been found to engage in “indirect” hedging activities related to upstream raw materials.

　　All of the aforementioned cases involve manufacturing enterprises that, after procuring raw materials, subject them to a certain degree of processing. Moreover, upstream basic raw materials significantly influence and account for a substantial share of the prices of the companies’ core products. Consequently, hedging against fluctuations in indirect raw material prices helps mitigate the impact of spot‑price volatility on corporate operations and investment, thereby demonstrating a reasonable business rationale.

　　Based on the aforementioned market cases, it is recommended that listed companies, prior to engaging in “indirect” raw‑material hedging activities, conduct a thorough assessment—covering aspects such as their business model, the accounting treatment of hedging (including the reasons for and rationale behind not applying hedge accounting standards, as well as compliance with relevant accounting standards like the Accounting Standards for Business Enterprises), and risk‑exposure management—to demonstrate that such activities fall within one of the six principal types of hedging transactions set out in the Exchange’s Guidelines on Trading and Related Party Transactions. Alternatively, in accordance with the catch‑all principle, they should proactively communicate with the regulatory authorities beforehand to obtain formal approval conofficeing the reasonableness of the proposed hedging activity.

　　Compliance Reminder: Disclosure Requirements for Hedging Effectiveness

　　Exchange‑related rules explicitly stipulate that when a listed company engages in futures and derivatives transactions for hedging purposes, it may, in conjunction with the characteristics of the hedged items, provide a comprehensive disclosure of the hedging effectiveness when filing its periodic reports. If the hedging activity does not meet the criteria for applying hedge accounting under the relevant accounting standards, or if hedge accounting is not applied, but risk‑management objectives can still be achieved through such futures and derivatives transactions, the company may, by describing the relationship between the hedging instruments and the hedged items, explain whether the intended risk‑management objectives have been effectively attained.

　　When engaging in hedging, listed companies should, based on the purchase and sale contracts for the underlying raw materials and their spot inventory, explain the effectiveness of the selected futures contracts in hedging the associated risk exposures. If comprehensive disclosure is difficult due to “indirect” hedging, it is recommended to provide a thorough explanation of how hedging gains affect the company’s financial position, and, in conjunction with trends in the prices of the company’s major raw materials, demonstrate the rationale for the hedging strategy and assess the extent to which the hedging objectives have been achieved.

　　Case: WKXC—Regulatory Action for Failure to Fully Disclose Hedging Effectiveness in Periodic Reports

　　Case Summary: The company engages in futures hedging activities; however, in its periodic reports, it discloses only the one-sided investment income and fair value changes of its futures positions, without fully reporting the profit or loss on the corresponding spot‑market contracts. As a result, the gains and losses from these futures investments have a significant impact on the company’s financial performance.