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TSI Market Watch March 24, 2014

Iron Ore Futures and Asian HRC Swaps Trading Surges in 2014 The growth in the volume of iron ore futures and derivatives cleared on the Singapore Exchange (SGX) continues apace. After January 2014 saw a new record monthly volume set of 31,672,000 tonnes, so far this month, after only 3 weeks, preliminary data indicates that number has already been exceeded by more than 5 million tonnes. With six trading days left in March, all indications point to this month seeing a 25% surge over January’s record, with monthly trade above the 40 million tonne mark for the first time.

Quiet Revolution?

Within this overall growth, another feature is emerging. Iron ore futures were introduced on SGX in April 2013, with screen-trading capability added in September. As the chart below shows, after a slow start, trading in futures has picked up strongly in recent months, with ‘chunkier’ volumes becoming clearly visible as a part of the wider trade in cleared iron ore derivatives.

Singapore Exchange Iron Ore Futures and Swaps Volumes Cleared and Open Interest

(million tonnes)

Source: Singapore Exchange * March 2014 volumes for period 1-20 March

The increasing prevalence of futures has been little remarked upon, as recent headlines have focused on the exceptional growth in the total volume of futures and derivatives being cleared.

Open Interest Leadership Changes Hands

In mid-February, the number of lots of open interest for iron ore futures moved past those of iron ore swaps for the first time. It had overtaken the open interest levels for iron ore options in January this year.

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Singapore Exchange Iron Ore Daily Open Interest (lots)

Source: Singapore Exchange

Does this trend towards futures have brokers quaking in their boots? Many people associate futures with screen-trading, as standardized contracts encourage faster ‘flow’, with electronic systems taking most trade. However, in iron ore, futures trade to-date has been largely voice-brokered, rather than screen-traded. Contracts are fully fungible with the more established swaps contract and, in practice, little different save for the smaller lot size. So there has been no panic among the Inter-Dealer Brokers (IDBs) in the rise of futures volumes. Indeed, most see good reasons to continue to use the voice market. When you want to hear the gossip, what trades have just happened, where people think the market is going that day, brokers are amongst the best people to speak to; a screen is rather mute in comparison.

It is not just open interest on futures which has been on the march – the number of futures lots traded daily has also been rising over that of swaps since the beginning of the year. For sheer tonnage, swaps are still where the volume lies – but the smaller volume futures contracts are trading rapidly throughout the day.

Singapore Exchange Iron Ore Daily Trading Volumes (Lots)

Source: Singapore Exchange

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And whilst the number of iron ore futures lots may now be well above those for either swaps or options, the lot size of 100 tonnes is smaller than the derivatives contracts, which both use 500 tonnes. In other words, in tonnage terms, the open interest on futures is still a great deal smaller than on swaps and options.

Though futures may lack the heft of swaps in terms of total market volume, their use has been rising swiftly since September, from almost nothing to 17.3% of the total volumes traded by February. The market continues to evolve and is becoming more complex and diverse. Combined, futures and options now account for almost 30% of the monthly iron ore tonnage on SGX – up from 7% in January 2013 - a big structural jump in a little over a year.

Singapore Exchange Iron Ore Volumes Cleared (million tonnes)

Source: Singapore Exchange

And there is certainly more to come, with many market participants expressing particular interest in learning more about the following three areas:

1) Options

2) Cross-Exchange arbitrage – specifically DCE/SGX

3) How to remove basis risk (between their actual physical buys and their hedged tonnes).

More complexity…and opportunity

The issues above may be the key interests of the iron ore trading community, but steelmakers have the added complexity of iron ore only being a part of their story. In China, mill wallets are hurting as installed capacity weighs on finished steel prices since demand has eased off. Elsewhere in Asia, mills are juggling increasingly short-term raw materials pricing – not just for ore, but for coking coal as well.

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Swaps, Options, Futures Tonnage (MT) Futures as % of total trade

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Source: Singapore Exchange. CME Group, LCH.Clearnet, NOS Clearing * Q1 2014 volumes to 20 March

The Shanghai Futures Exchange (SHFE) launched a new RMB-denominated Hot Rolled Coil (HRC) steel futures contract on Friday last week (March 21) putting mills in China in a position to trade both flat and long steel production ‘legs’ for the first time, from raw materials to finished product (whether sheet or rebar).

Mills outside of China are also latching on to the same opportunity, following SGX’s launch of its internationally-tradable US$-denominated Asian HRC futures and swap contracts last month, settling using TSI’s HRC index for ASEAN imports. This is a major development in price risk management for the steel industry – as a major mill in Asia Pacific put it recently, “until 22 days ago, we couldn’t hedge it all”.

So…how is the contract performing?

ASEAN HRC swaps and futures tread the same path as iron ore

The simplest way to assess the performance of SGX’s HRC swaps contract is through comparison to the iron ore swaps contract, although many would consider this harsh, given that iron ore has been one of the most successful commodity launches in a decade. Nevertheless, on that basis, the HRC swaps contract is not doing badly – clearing one more lot. To put this in context, the volume of steel traded is already equivalent to that needed to build just under 70,000 standard-sized automobiles.

Singapore Exchange: Volume of Swaps Cleared Following Launch

Source: Singapore Exchange

So far in March, 1,550 lots have been cleared, with a notional value of just under US$17 million.

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Iron Ore Futures and Derivatives Contracts - Volume Cleared (million tonnes)*

Iron Ore ASEAN HRC

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Iron Ore ASEAN HRC

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Days 12-23 over Days 1-11 after launch

Lots cleared after 23 days since launch

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Whilst trading is not taking place every day yet, when it does occur, more lots are being cleared than was the case for iron ore at this stage after its launch.

Singapore Exchange Daily Swaps Volumes Cleared Following Launch (number of lots)

Source: Singapore Exchange

Interest levels from the industry are high, with companies from across North and South Asia expressing a desire to use it and many in the process of making the necessary arrangements to begin trading. The main users so far have been European and Chinese companies.

In comparison with other hot rolled coil financial contract launches, the ASEAN HRC swap has been a big success. CME Group’s US domestic HRC contract is regarded as the most liquid internationally-accessible contract, yet it took nine months to post a higher volume than the ASEAN HRC contract has seen in March-to-date and 36 months for monthly volumes to average those for the ASEAN HRC contract for March-to-date.

HRC Swaps Cleared Following Launch

Source: Singapore Exchange, CME Group, LCH.Clearnet

In parallel, eyes will be squarely focused on the performance of SHFE’s contract following its launch, with early indications that it has traded around 937,000 tonnes on the first day.

Far from concern about a competing contract, many participants are excited about the launch. Some brokers mentioned that they expect the net result to be spreads tightening down the curve, as well as arbitrage trading between the two exchanges. As with iron ore, the market expects the launch to be ‘net additive’ to the SGX contract rather than a detraction.

The two contracts have important differences too. A major one is that SGX’s HRC contract is US$-denominated, the same currency used for trading iron ore and coking coal, as well as physical steel exports and imports to and from Asia.

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Days 1-11 184 1 1

Days 12-23 1,550 TD 1 0

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SGX and SHFE Asian HRC Contract Specifications / Key Features

Another is that SGX’s HRC contract is cash-settled, offering price risk management capability without the complexity and potential risks associated with delivery-based futures mechanisms.

The market is keen to see the SGX HRC contracts develop so that exporters and importers of Asian HRC are able to manage not just their input costs, but also their finished steel product prices too. Only then will mills really be able to start hedging their margins – and these are what the steel industry is keen to optimise, after all.

For further information

Please contact: Tim Hard (Singapore) +65 6530 6412 asia@thesteelindex.com

The Steel Index (TSI) is a leading specialist source of impartial steel, scrap, iron ore and coking coal price information based on spot market transactions.

Iron ore price indices are published daily at 19:00 Singapore/Shanghai time (11:00 GMT) and coking coal price indices daily at 18:30 Singapore/Shanghai time (10:30 GMT). Steel prices for Northern Europe, Southern Europe and US HRC are published daily at 14:00 UK time and for ASEAN HRC imports daily at 18:30 Singapore time. Scrap prices for Turkish imports are published daily at 13:30 UK time. Weekly steel and scrap price indices are published every Monday and Friday respectively, with each price representing the average transaction price for the previous calendar week.

Transaction price data is submitted confidentially to TSI on-line by companies buying and selling a range of relevant steel, iron ore, scrap, coking coal products. TSI’s index reference prices are then calculated using transparent and verifiable procedures.

TSI’s indices are widely used by steel mills, miners, traders, distributors and manufacturing companies worldwide as the basis for their physical pricing arrangements. TSI’s indices are also used as the industry standard in the settlement of ferrous financial contracts.

Singapore Exchange (SGX), LCH.Clearnet (London), CME Group (Chicago), NOS Clearing (Oslo), Intercontinental Exchange (ICE) and Indian Commodity Exchange (ICEX) all use TSI’s iron ore index for settling their monthly cleared iron ore financial contracts. SGX also uses TSI’s hot rolled coil index for ASEAN imports to settle its Asian HRC futures and swap contracts. In addition, TSI’s prices are used for the settlement of European hot rolled coil steel contracts and Turkish scrap imports contracts on LCH.Clearnet and CME Clearing Europe. In all cases, settlement prices are the average of TSI’s reference prices published in the expiring month.

TSI is a Platts business, part of McGraw Hill Financial. Further information on TSI, including a free trial of the service, is available at http://www.thesteelindex.com.

Platts, founded in 1909, is a leading global provider of energy, petrochemicals and metals information and a premier source of benchmark prices for the physical and futures markets. Platts' news, pricing, analytics, commentary and conferences help customers make better-informed trading and business decisions and help the markets operate with greater transparency and efficiency. Customers in more than 150 countries benefit from Platts’ coverage of the carbon emissions, coal, electricity, oil, natural gas, metals, nuclear power, petrochemical, and shipping markets. A division of McGraw-Hill Financial, Platts is headquartered in New York with approximately 900 employees in more than 15 offices worldwide. Additional information is available at http://www.platts.com

SGX HRC (SAE 1006) SHFE HRC (SS400)

ASEAN Imports China Domestic

Currency US$ RMB

Settlement Financial Physical

Daily moves Unlimited 4% cap

Lot Size 20 tonnes 10 tonnes

Calendar Months 24 12

Margin Post % 7 6

Other contracts Iron Ore Rebar

Focus Asia & Imports/Exports China Domestic