China eyes bigger role in iron ore pricing, hedging

The below article is by Reuters, is an excellent example of how the Chinese are becoming more sophisticated business people , one example of this is that they are utilizing advanced finance methods, hedging is one example of this. This is a very exciting time to be involved in the futures industry in the Greater China Market, if you have an interest in being involved please contact me, I would like to explore opportunities with you.
Best Regards,
David Nealis

Labourers work at an iron ore storage site at Yingkou Port, one of China's biggest ports

 Image: Reuters

China's plans to launch an iron ore swaps business and a physical iron ore trading platform are a clear sign of its desire to take on a bigger role in pricing its biggest import commodity and protect itself against increasing volatility.

A 31 percent slump in prices of the steelmaking raw material in October forced miners to alter costly quarterly contracts and spurred a move toward pricing that is closer to spot rates.

The drop, which brought prices to a 22-month low at below $117 a tonne, also raised the need for tools that will help China, the world's No. 1 iron ore buyer, hedge cost.

The investment banking arm of the Bank of China , one of the country's top four lenders, is planning to open an iron ore swaps business next year to tap growing demand for hedging from steel mills, sources told Reuters earlier this month.

About a week later, the China Beijing International Mining Exchange said it plans to launch the country's first physical iron ore trading platform at the end of December.

"Ultimately all of these things don't alter the demand-supply balance for iron ore which is ultimately what moves the price. What it might change is the ability to hedge prices," said Graeme Train, commodity analyst at Macquarie Bank.

The planned iron ore trading platform will not be China's first attempt. In May 2009, a few big private traders in China set up the country's first non-official iron ore trading platform, named Rizhao International Iron Ore Trade Center with the aim of publishing the country's first iron ore index.

But the China Iron and Steel Association soon shut the centre down, saying it would introduce speculation and destabilise the pricing mechanism which, at that time, set iron ore contracts annually.

The industry has since moved to quarterly pricing, spearheaded by global miners BHP Billiton , Rio Tinto and Vale eager to cash in on rising spot prices. It has been grudgingly accepted by Chinese mills, whose costs have consequently soared.

The new platform, which CBMX will set up jointly with Aluminium Corp of China and China Everbright Group, would be open to international and domestic iron ore producers, traders and steel firms. But in a bid to deter speculation, banks and financial organisations would not be allowed to participate.

China has long distrusted the mechanism at which iron ore, its biggest commodity import by volume, is priced.

With supply contracts based on reference price indexes published by non-Chinese companies, Beijing has complained that the indexes are prone to manipulation.

Many Chinese steel producers have stayed away from the market because of these manipulation fears, and also because they lack the knowledge and skill to trade in swaps.

"Chinese steel mills are concerned about speculation and manipulation by foreign investment banks and top miners, while they feel they are newbies and are more vulnerable to risks," said Han Xun, China manager with the Steel Index.

"Domestic banks, especially state-owned ones, are more trustworthy for steel mills who will be encouraged to learn and use more of the hedging tool amid a more volatile market."

Big firms such as China COSCO Holdings , CITIC Pacific Ltd and airline companies have made massive losses from derivatives bets over the past few years, forcing the government to toughen its rules.

Baosteel Group, the country's second-largest steel mill, and state-owned metals traders such as Minmetals and Sinosteel, had applications to invest in swaps rejected by the regulator.

Around 30 Chinese state-owned companies are currently allowed to make overseas derivatives investment, and only for hedging purposes.

The number, and skills, of Chinese derivatives traders is expected to rise with the entry of BOC International, the first Chinese bank that will engage in iron ore swaps in a market where major players include Deutsche Bank and Citigroup.

The bank will also bring with it Chinese clients foreign brokers have long sought since the cash-settled derivatives were launched in May 2008

BOC International plans to apply for clearing membership in the Singapore Exchange, which clears the bulk of globally traded volumes. In March, it was approved as a clearing member of CME Group, which also offers clearing of iron ore swaps.

"They've got a clear relationship advantage with guys in China," said Rory MacDonald, iron ore broker at Freight Investor Services (FIS), referring to BOC International.

"They will already be providing their businesses with financing and will leverage these pre-existing relationships. And from the point of view of the lender, there's much more surety that you're going to be repaid if somebody is using derivatives to manage risk on their physical book."

The volume of globally traded swaps soared to an all-time high above 9 million tonnes in October, with SGX clearing a record 7.5 million tonnes, as spot prices fell 31 percent.

BOC's move, if it succeeds, will encourage smaller-sized banks to follow suit as they all have clients in the iron and steel industry.

Financial institutions such as banks, securities firms and mutual funds are banned from China's commodity futures market without special regulatory approval.

But banks have been recently approved for special clearing memberships at domestic futures exchanges, which only allow financial institutions to sell the collateral of their clients, an official at Minsheng Bank, China's sixth largest lender, said.

"There are some 15 to 20 Chinese traders trading regularly and probably that same number again who are slightly less active. A year from now I expect to see that number to have at least doubled," said FIS' MacDonald.