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PrintChina's imminent launch of its first iron ore futures contract could pose a threat to the $28 billion swaps market in the commodity by exploiting massive untapped hedging potential at home.
The contract to be offered by the Dalian Commodity Exchange likely before year-end will be China's latest stab at boosting its power to price the world's second-largest traded commodity after oil as a more volatile iron ore market exposes its legion of steel mills to more risks.
By being the first yuan-denominated iron ore futures contract, the Dalian exchange can easily draw on the growing hedging appetite in China, a market that bourses in Singapore, the United States and Europe have been trying to tap for years.
Beijing has kept a tight rein on overseas derivatives trading by state-owned firms after many lost billions of dollars in offshore futures during the global financial crisis.
The lack of a domestic hedging tool has led Chinese companies to increase their use of the U.S. dollar-denominated cash-settled swaps offered by the Singapore Exchange (SGX) and CME Group.
"The market is in China, so Dalian's futures will attract a big number of domestic companies because this can help them avoid currency volatilities and restrictions which is a big challenge to Singapore's swaps," said Zhao Qian, a senior broker with CITIC Securities Futures in Shanghai.
"In the longer term, Beijing hopes to gain more pricing power via its own futures and it is hoping it can become a market benchmark."
China buys at least 60 percent of the world's seaborne iron ore and last year that reached a record 744 million tonnes, almost seven times the size of swaps cleared by the Singapore Exchange, pointing to the huge hedging opportunity in China.
"There's no doubt the Dalian exchange will do a lot because there is a hell of a lot of untapped liquidity in China that is not trading iron ore swaps," said a Singapore-based broker.
With more than 127 million tonnes traded last year, the swaps market accounts for just over a tenth of the 1.1 billion tonnes of seaborne iron ore sold annually.
But the volume is rapidly increasing. In January to September this year, nearly 210 million tonnes of swaps have been traded, valued at $28.3 billion based on the average price of about $135 a tonne. SGX clears over 90 percent of global iron ore swaps.
A launch of the futures contract may happen before the year ends after the Dalian Commodity Exchange secured regulatory approval in mid-September. It will be the first iron ore futures contract that is backed by physical delivery.
If the strong debut of China's thermal coal futures on the Dalian bourse is any indication, the iron ore contract should see brisk demand.
China is also the world's top consumer of coal.
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