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Dalian Commodity Exchange: First Anniversary Of Iron Ore Futures’ Internationalization

Date 14/05/2019

May 4 is the first anniversary of Dalian Commodity Exchange (DCE) ushering in overseas traders for its iron ore futures. DCE’s iron ore derivatives market is the only one of the largest scale in the world that adopts the singular physical delivery. Over the past one year of iron ore futures internationalization, the trading scale of overseas clients has increased rapidly, the market structure has been further improved, and the price influence has kept strengthening, providing global clients with an effective price signal and risk-avoiding instrument and handing in a satisfactory annual result.

Securities Daily learnt that in the first 4 months of this year, the iron ore futures corporate clients accounted for 47% of the total open interest, up by 10 percentage points compared with the same period of last year; the trading amount and average daily open interest were 83.14 million contracts and 770,000 contracts respectively. And the trading amount of iron ore futures in 2018 was 22 times of that of swaps and futures of Singapore Exchange (SGX), the world’s second largest iron ore derivatives market.

Corporate Clients: The “Main Force” in Transaction

In 2018, the year iron ore futures ushered in overseas traders, China imported 1.064-billion-tonne iron ore, down by 1% than 2017 and presenting the first negative growth in the annual iron ore import since 2010. Despite the slight decrease in import, the Chinese steel industry has continued the high-efficiency operation and seen remarkably improved market order. The supply-side reform in the steel industry started in 2016 has cut large amount of outdated capacity and renovated the supply and demand pattern of the steel industry, allowing it to maintain considerable profits and continuous output growth since 2017. In 2018, the output of pig iron and crude steel in China was 711 million tonnes and 928 million tonnes respectively, up by 3.0% and 6.6% year-on-year respectively and the latter hitting a new high. In the first quarter of 2019, the pig iron growth in China reached up to 9%.

While maintaining a good development, iron and steel enterprises have hedged against raw material and price risks via futures with higher proficiency. And futures-physicals integration has become a major trend in the development of the steel industry in recent years. At the beginning of 2019, great fluctuation has been seen in the international iron ore price as affected by the mine disaster in Brazil and the hurricane Veronica in Australia. In this context, enterprises in the steel industry chain have been more active in taking part in the Chinese futures market. In the first 4 months of 2019, the open interest of corporate clients accounted for 47% of the total, up by 10 percentage points compared with the same period of last year. “The Vale of Brazil mine disaster was a suddenly-happened event. But many companies have made overall arrangement in advance, thus reducing the adverse impact of the sharp rise of ore price on steel mills.” said Li Jin, a chief of Tangshan Wanyang Trading Co., Ltd.

Securities Daily learnt that the hedging efficiency of the Chinese iron ore futures has been about 80% since 2015, providing industry clients with an effective instrument to avoid risks. The trading amount and average daily open interest of Chinese iron ore futures in 2018 were 240 million contracts and 800,000 contracts (on one side, the same below) and those in the first 4 months of 2019 were 83.14 million contracts and 770,000 contracts respectively. In 2018, the trading amount of Chinese iron ore futures was 22 times of that of swaps and futures of Singapore Exchange (SGX), the world’s second largest iron ore derivatives market, maintaining its position as the world’s largest iron ore derivatives market and providing enterprises with sufficient liquidity for hedging.

With regard to market structure, iron ore industry clients have been increasingly active in taking part in the futures since the iron ore internationalization on May 4, 2018, and the proportion of open interest of corporate clients has increased steadily. In 2018, the average daily open interest of corporate clients took up 42.5% while that before the iron ore international was 36.8% and that after the internationalization increased to 44.3%.

The correlation of the futures and spot prices of iron ore reached 0.98 since the iron ore internationalization and its correlation with Platts Index and the SGX swap price maintained above 0.98. “The high correlation between domestic and overseas prices has provide many overseas trading participants with the opportunity of conducting cross-market arbitrage.” said Wang Mingjun, General Manager Assistant of the Institutional Business Headquarters of Orient Futures.

The increased influence of the futures market has made the spot market to attach increasing importance to the futures price fluctuation. Recently, the basis of futures and spot goods has been close at the beginning and then enlarged via fluctuation, mainly due to the periodical great bearish-bullish divergence in the market. But the restrained futures-spot basis will be the final trend.” said Cai Yongzheng, Director of the Securities Investment Department of Nangang Co., Ltd.

Till the end of April 2019, the accumulated delivery amount of iron ore futures was 5.79 million tonnes. The delivery sites were mainly ports in East China and the delivery ore products were mainly mainstream ore products. In particular, delivery has been made on 5 iron ore contracts since the iron ore internationalization, with the accumulated delivery amount of 1.79 million tonnes and the average delivery basis of RMB 27.2 / tonne (basically staying flat with the RMB 23.3 / tonne from January 2017 to the end of April 2018 before the internalization). The stable basis level has guaranteed that the futures settlement price will be effectively restrained before the expiration of the contract.

Overseas Clients: Seeking Domestic Futures for Risk-avoiding

With the accumulating of price fluctuation risks, both overseas mines and trading companies and domestic steel mills have encountered severe test in risk prevention and control. It is learnt that the cost of wining iron ore is generally more than $ 40 / tonne for all mine enterprises in the world except those in Australia. The iron ore price fluctuation will exert great influence on the revenue of relevant mine enterprises. It is estimated that the non-long-term-agreement amount of iron ore seaborne trade in the world exceeds 400 million tonnes and the trading volume of iron ore ranks the 2nd in the world. How to manage iron ore market risks via derivatives instrument has become a key issue for domestic and overseas industry enterprises.

The iron ore futures internalization that has been prepared for years was finally launched on May 4, 2018, symbolizing the opening-up of the first listed futures product in China and turning the Chinese iron ore futures market from a regional market to a global one. This has brought convenience for overseas mines, trading companies and other industry clients to take part and domestic and overseas clients can further carry out hedging, cross-border warehouse receipts on par, capacity value maintenance and other business. And the influence of uncertain factors in the market will be reduced. All these will help to realize the industry chain risk management across the world.

The internationalization has brought a direct change to the futures market -- ushering in overseas traders including such industry clients as mines and trading companies. Till the end of April 2019, 125 overseas clients, including industry clients like Glencore and Mercuria, have opened an account, mainly from 12 countries and regions like Singapore, Britain, Australia and Japan. And progress increase has been seen in the trading amount of overseas clients. In the first 4 months of 2019, the trading amount and open interest of overseas clients have increased by 637% and 264% respectively compared with those in the early period of iron ore internationalization (May - August, 2018).

With regard to the changes of market participants structure after iron ore internationalization, Cai Yongzheng said that the activity of iron ore futures trading has been enhanced since the iron ore internationalization on May 4, 2018, and the futures market participants have been increasingly diversified with many foreign-funded institutions taking part.

An official of the international trading company Mercuria pointed out that the relatively good liquidity and well functioning of the Chinese iron ore futures market has been the main reason that companies are willing to take part in its trading. Therefore, Mercuria has made sophisticated arrangements. For example, it has established a trading team, passed the examination on the trader suitability of specified products, set up the internal control, risk management, information disclosure and other regulations according to international rules, opened a NRA account in China, and prepared enough trading funds.

A DCE official said that apart from Glencore, Mercuria and BANDS International Finance which are the first batch of overseas clients after iron ore internationalization, many overseas enterprises have already taken part in iron ore trading as a domestic registered subject or via a domestic industry client agent. Rough statistics show that actually over 250 clients with foreign investment have taken part in iron ore futures, whose total trading amount account for 19% of the total since its listing.