In a tight race to launch the world’s first iron ore futures contract, India and Singapore could struggle to attract top consumer China because of Beijing’s rigid overseas investment rules and India’s recent policy moves.
The prize for the exchange that can establish the dominant pricing benchmark is potentially huge—becoming the hedging tool for a seaborne iron ore market worth around $100 billion in 2010.
Exchanges in both Singapore and India want to cash in on the iron ore market, second in size only to crude oil, at a time when spot prices of the steelmaking ingredient are nearing record levels around $200 a tonne.
But it may be tough for the bourses to attract Chinese steel makers, the biggest buyers of iron ore, given the strict regulations imposed on Chinese firms on overseas derivatives instruments.
“The overseas futures market regulations as far as China is concerned are quite restrictive as it recognizes the domestic markets more,” said Michael Gaylard, strategy director at Freight Investor Services. “And with iron ore being hugely China dependent you would expect that for an exchange to work, it would have to be able to grab that market.”
The Singapore Mercantile Exchange said on Wednesday it was planning to launch its iron ore futures contract in the second quarter, a day after the Indian Commodity Exchange (ICEX) said it was looking at launching its own iron ore futures within a month.
The Singapore Exchange, which clears the bulk of iron ore forward swaps globally, had seen its monthly volumes dwindle since hitting a record 2.2 million tonnes last April, a year after it was launched.
Chinese mills are only starting to warm to the idea of iron ore swaps as a hedging tool and analysts say selling another hedging instrument to them could be difficult.
“Chinese steel mills are unlikely to trade in iron ore futures in the near term,” said Jiang Zhiwei, an analyst with BOC International Futures.
“Just like swaps, it will take time for the futures market to mature and the Chinese are not experienced on iron ore derivatives.”
A more transparent pricing mechanism can only be effective if it has enough liquidity, which may be a tall task for a fledgling futures market that would be vying for business along with exchanges already offering swaps, analysts said.
Singapore and rival bourses in the US and Europe are competing for business in the forward iron ore swaps market, hoping to attract steel makers into hedging iron ore costs after the industry switched from a decades-old annual pricing system to a scheme where each quarter’s prices are based on the average spot market price in the previous quarter.
India’s recent policy moves towards iron ore exports may also work against it as potential futures market players could see them as non-investor friendly.
India is the world’s No. 3 iron ore exporter but shipments have fallen for a sixth straight month in December because of a ban on exports from Karnataka.
Top iron ore producing state Orissa is also looking at a similar ban and along with higher freight cost and talk that iron ore export duties may be raised, point to India trying to constrict exports to meet growing demand at home.
“It’s a very politically sensitive area and if you’re basing a futures market there, that in essence reflects an underlying spot market that is so open for change all the time, it’s going to be very difficult for them to get traction in that market,” said FIS’ Gaylard.
Another concern is the aspect of physical delivery which could be capital-intensive and quite complicated for iron ore given its varying grades. Copper by comparison has a uniform grade and at more than $9,000 a tonne is much more cost effective to store than iron ore, currently priced at less than $200 a tonne.
“A futures contract with physical delivery would be more useful for sellers and buyers but iron ore is very unlike copper,” said Henry Liu, regional head of commodity research at Mirae Asset Securities in Hong Kong.
“You have to have a huge storage facility and you need to monitor closely the quality and delivery conditions for the different grades.
“I think the learning curve will be high for everyone in the beginning,” added Liu.
Policy swings in India are also worrisome, traders said.
“There are a number of risks from the Indian government, which has banned futures trading in some markets before on the basis of national interest,” said an iron ore trading source from Australia.
India had banned trade in sugar futures in May 2009 for six months when prices were rising. The government again extended the ban until the end of September last year.
“The limited details about these contracts is also a worry to me. All things taken together, they may struggle to find enough liquidity for this to develop into benchmark contracts that the rest of the world pays attention to,” said the trading source.
SMX, controlled by India’s Financial Technologies , said it was looking at a cash-settled iron ore futures contract based on the iron ore index by data provider Metal Bulletin.
ICEX has yet to determine whether its contract will be cash settled or delivery based.
Singapore’s iron ore futures market, which will be open to foreign players, may have an edge over India’s.
India currently bars foreign funds from its commodity exchanges, limiting its influence as a price setter. But the commodity markets regulator expects institutional players to use new products including options and futures, which were cleared by the cabinet in September.
“The good thing about Singapore is it’s not directly involved in iron ore so there’s no cause or means by which it’s going to be seen to be moving the market in any particular direction,” said FIS’ Gaylard.
Nick Trevethan and Ruby Lian in Shanghai contributed to this story.