China's Step Toward Global Iron Ore Pricing Power: QuickTake

(Bloomberg) -- China, which purchases iron ore from around the globe to feed the world’s biggest steel industry, is opening its domestic futures market to international investors. It’s the latest step toward liberating its financial markets and another push to gain greater power over the pricing of key commodities. When trading begins on Friday in Dalian, iron ore will become only the second yuan-denominated Chinese commodities market open to the world following the start of oil futures trading in Shanghai in March.

1. Why is this important for China?

Chinese policy makers have long said they want to develop futures markets as hubs for setting prices -- using the country’s commercial heft to achieve a greater say in determining the cost of materials. In iron ore’s case, it aims to challenge benchmark prices provided by platforms such as Singapore Exchange Ltd. and Platts. The Dalian Commodity Exchange, where China’s futures are traded, is “opening the market to increase the credibility of the price and its profile as a global benchmark, enabling it to reflect world supply and demand in a more accurate and objective way,” it says on its website.

2. How is iron ore priced?

Until 2010, prices were set largely through annual contracts in private negotiations between suppliers and their biggest customers, for decades chiefly in Japan. The system broke down as the price for immediate delivery rose higher and higher above the annual level on the back of surging Chinese demand, and now shorter-term contracts use reference prices that are set daily. The market for iron ore is bigger than for any other commodity except oil and gas. Prices that soared amid China’s rapid urbanization are now at about one third the level of their peak in 2011.

3. Could yuan-denominated ore become a global benchmark?

Although it’s too early to say, there’s no doubt that China is where the action is: It absorbs 70 percent of the global seaborne iron ore trade. But Dalian has some catching up to do. Singapore Exchange probably had the greatest influence on the global market, according to a Goldman Sachs Group Inc. study in 2016. That said, Singapore’s facing competition not only from Dalian but from a product in Hong Kong that was launched late last year.

4. How active is trading in iron ore futures?

Steel and iron ore products were the two most traded commodity categories in China last year. Transactions in Dalian iron ore accounted for 11 percent of the total volume in Chinese commodities futures. That’s partly explained by the fact that individual investors play a far bigger role than in other markets, boosting trading volume but bringing with them far greater volatility. Speculation became so frenzied in 2016 that daily trading volumes at times exceeded the country’s annual imports. In 2017, almost 32.9 billion tons of Dalian iron ore contracts changed hands -- compared with annual imports of about 1 billion tons -- with a total value of 17 trillion yuan ($2.7 trillion), according to China Futures Association.

5. Will foreigners buy Chinese iron ore futures?

That remains to be seen. Overseas miners and traders would need to swallow not just China’s penchant for occasional market interventions -- as happened with commodities including iron ore in 2016 -- but also its capital controls. Restrictions on moving money in and out of the country have been tightened in the past two years after a shock devaluation of the yuan in 2015 prompted a surge in money leaving the mainland. Still, the early signs are that China’s nascent crude oil futures market is being used as intended as a physical market and not by speculators.

6. How do overseas investors trade in Dalian and when?

Qualified foreign traders need to open accounts at Chinese domestic brokerages. They can also trade and settle through qualified overseas intermediaries with ties to Chinese futures companies. Foreign traders and brokerages can use dollars as margin to trade in the products, which are settled in yuan. Daytime trading hours will be from 9 a.m. to 10:15 a.m., 10:30 a.m. to 11:30 a.m. and 1:30 p.m. to 3 p.m. local time and at night from 9 p.m. through 11:30 p.m. Unlike futures contracts listed in Singapore, which are settled in cash, the Dalian Commodity Exchange allows traders to settle expiring contracts only by taking or delivering physical iron ore in registered warehouses.

The Reference Shelf

• Why ore prices are seen slumping.
• China’s high inventories are hindering shipments.
• Global miners turn off the iron ore tap.
• A QuickTake on China’s new oil futures and another on iron ore.

--With assistance from Krystal Chia and Laurence Arnold.

To contact the reporter on this story: Alfred Cang in Singapore at acang@bloomberg.net

To contact the editors responsible for this story: Pratish Narayanan at pnarayanan9@bloomberg.net, Grant Clark, James Poole

©2018 Bloomberg L.P.