The second onshore China iron ore derivative contract takes volumes from Singapore as some Chinese industrial users look to avoid currency basis risk.
Volumes of iron ore swaps traded on the Shanghai Clearing House (SCH) since the contract was launched on August 4 have reached a third of the amount changing hands on the Singapore Exchange (SGX). However, market players say the latter's international role means that its leading global position in the contract is not under threat.
SCH, a central counterparty that provides clearing and settlement services for over-the-counter (OTC) products in China, debuted its iron ore swap contract by closing a deal between Citic Securities and two Chinese international trade groups - Xiamen International Trade Group and Heibei Jingye Group - earlier this month.
So far the China contract has picked up momentum with 24,056 contracts, or 2,405,600 tonnes of iron ore, being cleared by August 15, according to figures from SCH. This is over a third of the 6,052,500 tonnes traded by the SGX over the same 11 days. Indeed the 6,771,000 tonnes SGX traded in the first half of August (1-15 August) represents a 25% drop compared with the first two weeks of July, and a 53% year-on-year fall.
Market participants say the Shanghai swap has gained market share from SGX because the onshore contract is denominated in renminbi, compared to dollars for the Singapore contract, making the former attractive to China industrial users.
"Some of our industrial clients that used to trade iron ore swaps on SGX have scaled back and turned to the renminbi contract instead," says Xie Weiquan, Shanghai-based director at the iron ore swaps trading team of Huatai Great Wall Asset Management, a broker designated by SCH to trade its iron ore contract.
However, the Shanghai contract does not represent a threat to SGX, despite the declining volumes, as the latter is serving an international client base that trades in dollars, according to Lin Chen, iron ore analyst at Mysteel, a Shanghai-based commodity market monitor.
"The two swaps essentially serve different groups of clients," says Lin. "It's true that some investors have been directed back to China, but trading houses still need to purchase iron ore from foreign miners - otherwise where do the port inventories come from?" he says.
"Deals between miners and trading houses are like a wholesale market while the Chinese spot is a retail one. The wholesale market is traded in dollar and settled against the Steel Index (TSI), the international benchmark for iron ore. TSI, which generates irreplaceable hedging demand via the Singapore swap," he says.
Wang Xinpeng, an iron ore trader at Huashi Group, a Chinese commodity trading house that trades iron ore swaps in Singapore, agrees with Lin over the importance of the role the TSI index plays in driving business to Singapore.
"As long as the TSI index is used by major miners as a settlement standard, the SGX swap will continue being needed by investors," he says.
Tan Say Liang, Singapore-based vice president from the department of commodities product development at SGX, agrees with both of the China-based iron ore players.
"SGX's iron ore derivatives are preferred amongst international physical hedgers with nearly 60% of SGX iron ore market participants being Asian steel mills, trading houses and iron ore miners. The price of the contracts shows a strong alignment with the physical seaborne prices and how the longer term structure of the SGX iron ore prices provides insight into market sentiment."
"From a long-term perspective, the trading activities of iron ore derivatives on SGX will be sort of reduced as a part of Chinese clients will move back to China. However, the impact is limited. SGX will continue serve as one of the major platforms for global players," says Cao Bo, Shenzhen-based analyst at Jinrui Futures, a Chinese futures broker owned by Jiangxi Copper, one of the biggest copper miners in China.
SGX launched the iron ore swap in 2009 and currently accounts for 90% of global transactions of this type. In 2009 there were no derivatives available onshore in China to hedge iron ore exposures. However, this situation changed last year with the launch of iron ore futures on the Dalian Commodity Exchange, followed by the Shanghai contract earlier this month.
According to Mysteel's Chen, the structure of the China iron ore market has been helpful to the Shanghai contract launch by increasing onshore industrial firms hedging needs.
"The oversupply of iron ore since earlier this year has driven the price of spot cargos in China down significantly. Many steelmakers that used to purchase iron ore directly from the big three [BHP Billiton, Rio Tinto and Vale] have switched to the Chinese spot market as it is cheaper. For this reason they need to hedge their physical exposure with the domestic swap accordingly," says Chen.
The iron ore price has been under pressure since earlier this year due to a combination of oversupply, tighter access to financing for steelmakers and the slowdown of the Chinese economy.
According to figures from Mysteel, spot iron ore with 62% content in Qingdao Port is currently traded at four dollars a tonne lower than the same degree iron ore for immediate delivery to China published by the Steel Index (TSI), a global price provider for the ferrous market.
As a result, many Chinese steel mills have cut back on long-term contract deals with big foreign miners and pursued the port inventories instead.
In line with the spot iron ore traded in renminbi, the swap contract in China is denominated in renminbi as well. Whereas the Singapore swap that refers to TSI's iron ore reference prices as settlement standard, the Chinese contract is cleared against the Chinese domestically compiled index.
"The fall of price in spot market actually provides a good timing for China to introduce its own version of swap," says Xie. "It does not make sense if you buy iron ore in China in renminbi but hedge in Singapore in dollar."
Source: risk.net