The China Securities Regulatory Commission (CSRC) issued a draft regulation on Tuesday for foreign investors under the Qualified Foreign Institutional Investors (QFII) program to trade stock index futures in a move to further open the country's financial market.

Like their domestic institutional counterparts, QFII investors are allowed to trade stock index futures only for hedging, not speculative purposes, according to the draft.

The regulator also limited the trading volume, requiring that the daily value of futures contracts a QFII investor holds and the daily transaction volume may not exceed the quota approved by the country's foreign exchange regulator.

"The purpose is to prevent sharp market fluctuations, and we think the current quota could meet the hedging demand of QFII investors," a CSRC official said, adding that the regulations will be relaxed in the future by gradually raising the investment quota of QFII investors.

In the meantime, QFII investors may not use index futures as an instrument to sell financial derivative products in overseas markets. And they may choose no more than three domestic futures companies to open accounts and one bank to make trading deposits.

The CSRC said it is still discussing with the foreign exchange regulator the issue of overseas investors opening deposit accounts in domestic Chinese banks. The draft will be open for public comment until Feb 12 before the final rules are issued.

China launched the trading of stock index futures - agreements to buy or sell the CSI 300 Index which tracks 300 large-cap stocks traded in Shanghai and Shenzhen at a preset value - in Shanghai in April 2009.

It marked a milestone in the nation's efforts to make its capital market more professional as it allows investors to short the market for the first time. Before the introduction of index futures trading, investors in China could bet only on the market rising.

But foreign investors have been barred from trading index futures owing to regulators' concerns about market instability.

Market watchers believe that allowing QFII investors to participate in trading index futures will give them a necessary hedging tool in China and make more options available to foreign investors, who have limited access to the world's second-largest stock market by value.

The foreign exchange regulator granted quotas worth about $19.72 billion to 97 QFII funds by the end of December.

Analysts said that the participation of institutional investors and large hedgers is essential for index futures to develop to their full potential and will also help ease the Chinese market's notorious volatility in the long run.