Iron Ore Swaps

Published November 17, 2011

BOC unit plans iron ore swaps business (SHANGHAI) A unit of the Bank of China (BOC), one of the country's top four banks, is planning to kick off an iron ore swaps business next year in a bid to tap growing demand for hedging from steel mills and traders, two sources familiar with the matter said.

The entry of a major bank from the world's top iron ore buyer could bolster liquidity of the nascent swaps market, and signal a further warming to derivatives in China's state- dominated steel sector as prices of the main raw material become more volatile.

BOC International (BOCI), the investment banking arm of the state-owned bank, aims to provide brokerage services, proprietary trading of iron ore swaps as well as physical trading.

'The bank plans to start an iron ore swaps business in the first half of next year, with the aim of providing hedging services for domestic players first,' said one of the sources. 'It also plans to apply for clearing membership in the Singapore Exchange (SGX) next year.'

BOCI was approved as a clearing member of CME Group in March. The CME and SGX both offer clearing of iron ore swaps, with the bulk of globally traded volumes cleared on the SGX.

The source said that BOCI has also applied for category two membership on the London Metal Exchange (LME), which would give it access to all types of LME business except ring trading.
A spokeswoman for BOCI said that she could not immediately comment.

Demand for iron ore derivatives has swelled in recent years given a shift away from annual contracts for the commodity, with a growing number of investment banks and traders venturing into the sector.

The move by BOC is the latest sign that Beijing is moving onto the global stage as it looks to play a greater role in setting world prices for the raw materials that power its fast-growing economy.

Earlier this year, Chinese regulators allowed three of the country's futures brokerage firms to prepare to participate on overseas commodity exchanges.

The overseas foray by BOC and other brokerage firms will help overcome the advantage that foreign banks currently have in helping Chinese firms hedge overseas.

But growing demand from Chinese firms for hedging could also see Beijing accelerate the pace of opening domestic commodity exchanges, the world's largest by traded volume, to foreign players.

'The market certainly needs the big liquidity boost coming from China to make this a market where you can genuinely hedge physical risk,' said an iron ore swaps broker in Singapore.

'If it happens, it shows a bit of softening in China's stance on derivatives,' he said.

Last year's breakdown of a 40-year-old system of pricing iron ore annually in favour of a more flexible quarterly scheme encouraged some Chinese mills to consider hedging risks via swaps, although many remained wary.

Baosteel Group, China's second-biggest steelmaker, in September warned Chinese mills to exercise caution in trading swaps, saying that global miners were able to influence index reference prices used in swaps.

Launched in May 2008, iron ore swaps are cash- settled contracts that allow steelmakers and traders to hedge price risks.

The volume of globally traded swaps soared to an all-time high above nine million tonnes in October, with SGX clearing a record 7.5 million tonnes, as prices gyrated wildly.

Iron ore gained 25 per cent in the past 12 trading days, after sliding nearly 31 per cent in October when Chinese mills cut purchases of iron ore as lower steel prices reflected weaker demand.
Iron ore rose nearly 6 per cent to US$146.30 a tonne on Tuesday, according to the Steel Index. -- Reuters

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