The iron ore futures of Dalian Commodity Exchange (DCE), the world's first iron ore futures contract with physical delivery, has maintained a steady development trend in the one year since the listing, with the market liquidity improved continuously, the quality and efficiency of the market operation constantly enhanced, the futures market functions of price discovery and hedging gradually achieved, the profound impact found on the international iron ore pricing mechanism, and the role of the market in serving the industries and the real economy brought into play.
Rapid Growth and Sound Operation of Iron Ore Futures
Since the listing on October 18, 2013, the DCE iron ore futures has laid a solid foundation for the market to function and serve the industries, with the market liquidity continuously improved, the operation in a steady way and the influence constantly expanded. According to statistics, as of October 17, 2014, the total trading volume of the iron ore futures reached 67.6402 million contracts (unilaterally, the same below), with a turnover of RMB 4.7 trillion, a daily average trading volume of 276,100 contracts, a daily average open interest of 290,200 contracts and an equivalent of 6.764 billion tons of spot goods in trading volume. According to the spot trading volume, the iron ore has become DCE’s second-largest product next to the coke. On the comparable basis, the cumulative trading volume is about 23 times and 54 times of Singapore iron ore swaps and futures and 428 times of those of CME in the U.S. With the daily average open interest ratio to Singapore swaps market raised from 0.32 in 2013 to 1.26 in 2014, the domestic iron ore futures market has been deeper than the overseas derivatives markets of the same kind. With the expanding size, the market has run smoothly. Especially in 2014, the spot ore prices have been in decline, the enterprises are in urgent need of hedging, the trading volume and the open interest of the iron ore futures have been increased rapidly with the monthly average growth at 50.51% and 29.93% respectively, the highest intraday trading volume at 717,200 contracts and the highest open interest at 458,400 contracts, the futures prices have fluctuated in an orderly way in the movement of trend and the market has run soundly, showing a strong capacity for self-balancing. The continuously improved liquidity and the smooth operation of the iron ore futures market have laid a solid foundation for the functioning of market price discovery and hedging.
Diversified Investors Structure, Active Participation of Industrial Clients. According to statistics, so far the total number of the clients participating in the iron ore futures has reached 125,700 with the daily average turnover of corporate clients accounting for 39.60% of the total and the daily average open interest accounting for 30.63% of the total. The diversified structure of investors including mines, iron and steel enterprises, traders and other industrial clients as well as funds, private equities, futures asset management and other institutional investors has been formed. The overall high level of corporate clients’ participation demonstrates the significant market influence of the iron ore futures and the strong interests of the spot enterprises in participating in and making use of the market.
Since March 2014, with the exacerbated financing risks on the iron ore spot market resulting in sharp volatility of the market prices, the industrial clients have been much more active in participating in the futures market with the corporate clients accounting for 57.92% of the total at most, indicating that the influence and representativeness of the futures prices have been fully recognized by the market, and the motivations of the spot enterprises for hedging and the professional institutions for investment have been intensified.
Smooth physical delivery ensures connection of futures and sport markets. Whether the physical delivery can be successively implemented for the iron ore futures, the first adopting the physical delivery, will affect the achievement of the long-term goal of the iron ore futures market as a pricing market.
Since the first delivery for the I1403 Contract, the iron ore futures have attained 360,000 tons of delivery including 10,000 tons, 170,000 tons, 50,000 tons and 130,000 tons for the Contracts of 1403, 1405, 1406 and 1409 respectively; in terms of the delivery site and the category of the warehouse receipt, a total of 140,000 tons in warehouse delivery has been completed in Rizhao Port, Lianyungang Port and Tianjin Port with 220,000 tons in factory warehouse delivery achieved in Jiangsu Sha Steel (Lianyungang) and Sinosteel (Rizhao). In the delivery all the commodities are the mainstream ore products on the market with high quality with the market-concerned mixed ores and inferior ores not seen in the delivery. All the processes of the warehouse delivery and factory warehouse delivery were smooth and the participants such as the steel mills and the traders have experienced the transition from learning about the costs, getting familiar with the processes and attempting the delivery at the early stage to improving the hedging strategies and modes through scale delivery, further demonstrating the rationality and the market recognition of the design of the delivery system. Overall, the smooth delivery has made the physical delivery system successful in the market test, laying a solid foundation for the development and improvement of the iron ore futures in the future.
Iron ore futures market functions well with service for industries highlighted.
Market researchers pointed out that since the listing of the iron ore futures, the imbalance of supply and demand on the iron ore market, the industrial restructuring and the changes in the financial market conditions and other factors have resulted in significant fluctuations of the iron ore prices and especially the trend of rising iron ore prices for 10-plus years has come to an end this year. The future trend of the iron ore will undoubtedly become the focus of concern, and the market is also in urgent need of authoritative prices accurately reflecting the supply and demand as the reference for the production and operation. The rapid growth and sound operation of the iron ore futures market have increasingly brought its functions in price discovery and avoiding risks into full play.
Function of price discovery brought into play. Market participants believed that in recent years, the tight supply and demand for iron ore has caused the prices to run at high levels. Meanwhile, there are also the phenomena such as the overall market determined by the minor samples as a result of the opaque market and the information asymmetry and the indexes determined by ordinary biddings, and the supply and demand of the domestic spot market can hardly be reflected accurately.
In the iron ore futures market, with the open and transparent price formation mechanism, adequate attention and consultation of the market participants and full exploration and utilization of the information, the futures prices are open, transparent and predictive.
In terms of the effect of the price operation after the listing, with the constantly expanded market size and the continuously improved influence of the prices, the iron ore futures price has become one of the important reference prices influential on the market together with the Platts index, PB powder spot price, the CISA index and the SGX swaps. It is noteworthy that the futures prices have played some role in guiding the Platts index. The relevance between the iron ore prices and the Platts index is as high as 0.98, and the Platts index is released after the closing of the iron ore futures. Market analysts thus believe that in terms of time the futures prices will inevitably affect the formation of the Platts index and change the routine of the Platts index rising rapidly and falling slowly and recording more increases than decreases. The iron ore futures have begun to affect the pricing mode of the iron ore market. According to a recent market survey conducted by market institutions, among the 60 spot enterprises participating in the survey, 85% of the clients believe that the listing of the iron ore futures prompts the Platts index to objectively reflect the supply and demand of the domestic market.
Meanwhile, the correlation between the futures prices and the spot index prices at home and abroad is increasingly enhanced to stand above 0.97 at present, demonstrating the rationality and effectiveness of the futures prices. With the iron ore futures becoming increasingly brisk and the number of the participants gradually growing, the price difference between the spot price indexes at home and abroad and the iron ore futures shows the tendency toward stability. For example, at the early stage of listing, the indexes and the iron ore futures showed significant price differences, with the price difference between the SGX swaps and the iron ore futures recording the negatives. With the participation of the industrial clients and the quality of market operation continuously improved, the price difference between the iron ore futures and the related markets has been gradually narrowed.
In addition, the correlation of the iron ore and the coking coal, coke, rebar and other related products is increasingly enhanced, with the correlation indexes between the iron ore futures and the coking coal futures, the coke futures and the rebar futures on Shanghai Futures Exchange increased from 0.49, 0.15 and 0.29 respectively at the early stage of listing to more than 0.98 at present.
The iron ore futures prices and the spot index prices show basically the same trend of operation, indicating that the open and transparent futures market fluctuating around the spot market can soundly reflect the market supply and demand and provide more and more enterprises with reference for trading, and the prices have even affected the investment in international markets. According to a March report of "Australians", an Australian media, the DCE iron ore futures contracts have adequately shown the prediction for the price fluctuation of the spot market, and even become a wind vane for the stock prices of the mining enterprises on the securities market. On March 10 in particular, the DCE iron ore futures contracts took the lead to go down, followed by the decline of the Platts spot price, and the futures prices guided the international investors in selling the stocks of BHP Billiton, Rio Tinto and other companies to avoid investment losses.
Obvious display of the risk-avoiding function. The great agreement of the price trend of iron ore futures and spot goods and the sufficient market liquidity have both provided relevant industrial enterprises with bases and conditions for risk-avoiding. More and more relevant market participants have made use of the futures market to avoid risks and stabilize profits, thus giving birth to new pricing, hedging, and investing patterns. Recently, with the centralized release of mining capacity and the slowdown of domestic steel demand, the ore price has dropped from US$ 130/ton at the beginning of this year to less than US$ 80/ton at present. Besides, once landing, it will face the risk of cross-border price inversion of RMB 30/ton. Many spot enterprises said that this year’s spot goods can hardly be operated without iron ore futures.
Judging from the hedging efficiency of iron ore futures, till the end of September, 2014, altogether 58 enterprises have applied for hedging and 53 obtained the hedging qualification and the daily hedging position-holding proportion has increased from 0.23% in November, 2013, to 6.09% in 2014, with the average monthly growth of 73.71%. And the proportion of those directly hedging in the futures market without application is even higher. In terms of the hedging efficiency, the weekly hedging efficiency has gone up from 12.50% in 2013 to 46.20% in 2014 and the monthly hedging efficiency from 20.96% in 2013 to 68.07% in 2014.
With regard to the common risk-avoiding through hedging, participating spot enterprises are relatively skilled at the practice. For example, Guofeng Iron and Steel in Tangshan, Hebei Province, has explored a pattern to conduct raw materials and product risks management through the futures market. In this year when the steel export situation is relatively good and the export has increased, the company, worrying about the rise of raw material prices in the later period, first signed sales contracts with overseas clients to make sure the forward sales price and meanwhile purchased iron ore futures in the futures market to lock in corresponding profits. When purchasing spot iron ore, it closed the futures positions, thus realizing the buy hedging toward raw materials and avoiding the risk of price fluctuation.
The iron ore futures, together with coal, coke, and steel products, have jointly improved the investment system of the whole industry chain. As a result, spot enterprises and investors can make combination among coking coal, coke, iron ore, rebar steel, and other futures products, thus constructing a diversified risk-avoiding and investing pattern in the industry chain. For example, a large steel mill in Shandong province with the annual output of over 20 million tons of steel established the futures department after the listing of iron ore futures and special personnel have been designated to be in charge of order placing, risk managing, and delivery. Besides, the futures department is connected with the company’s sales, purchasing, and other relevant departments to serve production by utilizing the futures. Regularly, the company conducts hedging in line with the difference in futures and spot prices and meanwhile conducts arbitrage by using raw materials and finished products and conducts hedging in line with purchased raw materials, such as buying in iron ore while selling out steel. In this year, however, when the raw materials and steel both present downward tendency, the company has operated flexibly. For example, it sold out when the iron ore futures price was RMB 720/ton and the rebar steel futures price was RMB 3,100/ton and closed the position when the iron ore futures price reached RMB 650/ton in the later period. It has held the rebar steel futures and finally decided to conduct delivery to ensure part of the profits, thus solving steel mill’s order sales issue.
Speaking of the hedging function of the futures market, relevant person in charge of Jiangsu Shagang Group, said with deep feelings, “when the spot prices drop significantly, enterprises will sell out goods out of panic if with no futures and particularly when it has a relatively high amount of raw material inventory. But now, we can conduct hedging by selling futures and lock in risks, thus feeling quite assured.” After the listing of iron ore futures, the strategies and patterns of enterprises in participating and utilizing futures are also diversified. For example, they can conduct arbitrage through iron ore futures, Singapore swap, and Platts index. In the first half of this year, the domestic and foreign price difference is relatively large and the Singapore price is US$ 10 higher than Dalian price. To ensure the reasonable stock structure, the company has sold out the Singapore swap and bought in iron ore futures, with an aim of trying to reduce factory inventory while ensuring the normal production and operation of the factory.
It is learnt that the export amount of Shagang’s products is very large, almost double that of last year, and most are in the form of make-to-order. For example, it received the order of December in September. As most orders are for export, the company has a strong will in conducting hedging on such raw materials as iron ore. When the iron ore futures price is lower than spot price, the company will lock in risks through futures hedging.
Apart from cross-market arbitrage, Shagang has also adopted cross-product arbitrage strategy as the futures products in the black industry chain have been increasingly improved. For example, it can ensure processing profits by buying in iron ore futures and selling out rebar steel futures according to the raw material ratio. It is introduced that in the beginning of this year when the rebar steel price was about RMB 3,400/ton and that of iron ore was RMB 700-800/ton, the company decided to sell rebar steel and buy iron ore, which was proved to be a right and effective practice in the later period.
This person in charge also said that after the listing of iron ore futures, the enterprise itself has become more confident in spot operation. Previously, its destiny was controlled by others and it would feel panic once the market presented a sign of disturbance or trouble. Currently, everyone can operate though futures and thus would not feel panic as before. As a market participant, the company has transformed from the previous “betting on spot goods” to the present operating on futures and thus need not to “bet on inventory”. At present, the inventory in the steel mill is 25 days on average, about 10 days less than the previous 35 days. It dared not to press the inventory to such a low level previously, especially when there were some seasonal factors. Before the listing of iron ore futures, the company probably had no way to buy in spot goods and the price might increase before the winter, which forced it to increase inventory in advance. At present, however, when there is futures available and particularly when the discount status of futures against spot goods has presented recently, the steel mill will conduct hedging by buying in futures at any time and thus avoid the need of increasing inventory out of panic.
The basis pricing trading mode in the mature international futures market has also appeared in the iron ore futures market. For example, in July this year, Rizhao Steel Group signed the iron ore basis trading contract with Yong’an Futures and CITIC Global and the former completed pricing within one month with the I1409 contract as the bench mark price and with certain premium and discount standards. The occurrence of mature futures market’s regular pricing and risk avoiding mode in the iron ore futures market symbolizes a substantial step forward of iron ore futures in spot trade pricing. Zhu Jimin, Vice President of the China Iron and Steel Association, believed that introducing basis pricing – a pricing mode generally adopted in the international market and mostly adopted by domestic agricultural industry, especially the feed and oil industry – in the coal, coking, and steel fields has shown a great step forward of the steel industry in utilizing the futures market.
Dispelling Market Concern before the Listing, Market Construction and Development Being Highly Recognized
At the beginning of the listing of iron ore futures – an important bulk commodity that seconds to crude oil in terms of its strategic position and closely relates to the national economy, the market urgently expected the early listing of iron ore futures while some people worried about whether it can operate soundly and bring off its due functions, such as whether physical delivery will be applicable, whether the futures prices will be more likely to be monopolized by mining magnates, and whether the iron ore futures market will lead to new financial risks. One year since then, the iron ore futures has, with its steadily-operating market, relatively high liquidity, price effectiveness, and market influence, handed over a satisfactory report to the market and also dispelled the worries that some market participants had at the beginning of its listing. In a word, the construction and development of the iron ore futures market have been highly recognized.
Judging from the market price operation, the futures prices have not been monopolized and, on the contrary, have played positive roles in the spot market prices formation that had always been disputed. Since 2010, global iron ore pricing mechanism has transformed from the traditional annual pricing into seasonal pricing, monthly pricing, and spot pricing. Under the short-term pricing mechanism, the iron ore prices experienced great fluctuation and the seller mainly dominated the market pricing, which have made China, the largest buyer in the world, maintain a weak position in iron ore trade negotiations. After the listing of iron ore futures in 2013, the situation that relevant domestic enterprises were forced to receive international iron ore prices has begun to change. Person in charge of the futures department of Shagang said in the interview, “Before the listing of futures products, the prices of most products in spot market were not transparent and the listing of futures products has helped to make the prices more transparent.” Speaking of the pricing finding of iron ore futures, this person said, “The futures prices are prospective, which will point out a direction for enterprises to purchase raw materials and sell finished products. For example, in a period when the futures prices are lower than spot prices and present a discount status, enterprises will judge that the market will not be good in a long term and thus temporarily delay the raw material purchase and meanwhile sell its products in advance.” He emphasized that iron ore futures have played a significant role in guiding the manufacturing and operation in spot market after its listing.
Market participants believed that the import of iron ore, a product with the dependence degree on import of over 60%, has always been in the “monopoly” pricing dispute of international ore magnates and the listing of iron ore futures, with its gradually increasing international influence, will help China to compete for the iron ore pricing power. One person in charge of a spot enterprise said that previously it was the Platts index that counts, with several ships of goods able to influence the index and a private transaction able to decide the prices of the whole market, which is no longer the case now. This shows that iron ore futures have exerted great influence on Platts index. Meanwhile, futures prices are transparent, which, along with such design as the position limit mechanism, makes them unfavorable to be manipulated. Besides, the great price guiding capacity and sufficient liquidity have also provided enough room for enterprises to avoid risks.
According to the questionnaire from a market organization, with the continuous increase of the operation quality of iron ore futures, 71% of customers believed that futures prices are more able to reflect the supply and demand relation in domestic spot market and nearly half (46.7%) of the industrial customers supported to conduct pricing in line with futures prices. Chai Zhiyong, Vice General Manager of Shanxi Taigang Stainless Steel Co., Ltd., pointed out at an industrial conference that in the future, it should consider to set up monthly prices in line with DCE’s iron ore futures and to decide the premium and discount in accordance with the strategic cooperation degree and supply and demand situation of the buyer and seller.
With regard to the dispute between index and physical delivery before the listing, a market analyst pointed out that market practice has proved that compared with iron ore index derivatives in the international market, the iron ore futures engaged in domestic physical delivery have more advantages. During the only one year since the listing, the scale and liquidity of China’s iron ore futures have far surpassed those in the Singapore market. Till the end of September, 2014, the trading scale of iron ore futures is about 23 and 54 times of that of Singapore swap and futures. In terms of the daily trading situation, the ratio against the Singapore swap market has increased from 4.85 in 2013 to 27.30 in 2014 and that against the Singapore futures market has increased from 39.3 in 2013 to the current 55.14. With regard to the daily position holding, the ratio against the Singapore swap market has increased from 0.32 in 2013 to 1.54 in 2014 and that against the Singapore futures market from 3.47 in 2013 to the current 3.62. Domestic iron ore futures have sufficient liquidity, which is favorable for industrial customers to open a position successfully. To open a position of over 300,000 tons in the Singapore market, about 25% of its daily trading amount, it generally needs 2-3 days, while 300,000 tons (3,000 contracts) only accounts for 1% of the daily trading amount in China’s iron ore futures market and the position opening can be completed within one day.
Market participants reflected that at present some domestic traders and steel enterprises participating in the Singapore iron ore derivatives trading have returned to domestic futures market for risk-avoiding and large amounts of hedging positions have transferred from Singapore to domestic futures market. For example, the hedging ratio of a trading enterprise in Rizhao (Shandong Province) in domestic futures market has risen from the previous about 10% to the current nearly 100%, with about 60% hedging through iron ore futures and the rest through coking coal, coke, and relevant products. Iron ore international traders have also felt the strong development potential of China’s iron ore futures. With the increasing influence of iron ore futures, international traders have transformed from its initial watch-and-wait and unwilling to participate attitude towards the iron ore futures to the current enthusiastic and preparing to participate attitude. It is learnt that some international ore magnates have shown their willingness to use domestic enterprises to participate in the iron ore futures market and conduct physical delivery.
At the 2014 CCIC recently held in Qingdao, Wang Xiaoqi, Vice President of China Iron and Steel Association, said that DCE’s iron ore futures, with the stable operation and good function display, have become a price finding tool that has been widely recognized by domestic and foreign market participants and all market participants have the futures prices for reference, thus totally changing the unfavorable situation that the information asymmetry led to wild speculation that can hardly be judged. At the 14th China International Steel & Raw Materials Conference recently held in Dalian, Wang Xiaoqi further pointed out, “A new order for the iron ore market should be co-constructed at proper time, the core of which is to allow market prices to truly reflect the supply and demand relation. Under the current market situation, the new order should also include more spot trading, transparent and diversified price indexes, futures platform, and the regulation on market monopoly.” This comment has demonstrated the industrial circle’s highly recognition and expectation on the operation and development of the iron ore futures market.
Continuing to Cultivate Iron Ore Futures Market and Promote the Market’s Internationalization
In the interview, market participants believed that at the initial period of the launching of the international iron ore derivatives market, the listing of domestic iron futures has seized the development opportunities of the international iron ore derivatives market. Meanwhile, as the world’s largest iron ore consumption country, China possesses strong support from its spot market and iron ore might become the most advantageous product for China to compete for the international bulk commodity pricing power.
Hu Yuyue, President of the Securities and Futures Research Institute of Beijing Technology and Business University, said that judging from the development of the international derivatives market and the evolution of the commodity pricing power, the launching of derivatives has provided the platform and chips to compete for the pricing power, but the pricing power is also related to the development degree and the openness of the financial derivatives market. Particularly, the market’s openness is one of the important basic conditions to compete for the international pricing power. Therefore, the future development of the iron ore futures market should adopt the two-step strategy. The first step is to bring off the futures market’s price finding and hedging functions through launching and cultivating iron ore futures, thus providing the industry and enterprises with an open and fair price reference and a risk-avoiding tool and providing a platform to increase the pricing power of domestic iron ore. On this basis, the second step is to actively promote the internationalization of iron ore futures, introduce overseas investors, and strengthen the authority and influence of the prices, so as to compete for the iron ore pricing power.
Relevant person in charge of DCE said in the interview that China’s coal, coke, and steel futures products have presented rapid development and good momentum but, compared with overseas developed futures market and other mature products in domestic futures market, the market width and depth of relevant products are not enough and there are still much market cultivation work to be done in terms of market mechanism, investor structure, and participation degree of industrial customers. With regard to further promoting and improving iron ore futures, DCE will proceed from the flowing aspects. The first is to keep improving contracts, risk management, delivery, and other mechanisms, with an aim of enhancing market efficiency and bringing convenience to enterprises. For example, it will research to solve the discontinuous problem of dominant contracts and provide delivery services to more investors with delivery enthusiasm by relying on spot traders. The second is to keep increasing the market cultivation efforts. Since the listing of iron ore futures, DCE has always regarded industrial enterprise training and participation as the focus of market cultivation. And it has conducted several industry chain research activities and held the hedging training classes and risk control senior seminar for coal, coke, and steel enterprises. Next, it will continue to do well in market cultivation, guide more industrial customers to well use the tool of iron ore futures, explore new modes of serving the industry, and support and encourage more enterprises to effectively participate and utilize the futures market. The third is to explore new derivative instruments such as swap and index, enrich the product and tool systems, and meet enterprises diversified risk-avoiding and investors’ investment demands. The fourth is to promote products’ internationalization. At present, DCE is active in researching and formulating the internationalization scheme for iron ore futures. Under the overall arrangement of the capital market’s opening-up strategy, it has, through exploring and conducting iron ore bonded delivery, introduced qualified overseas investors and enhanced the market’s international influence, striving to make iron ore the futures product with international pricing power in China.