In global commodity trading, Asia is where it’s at. Not that all the trading activity has migrated to Asia – far from it. Chicago, New York and London are still big hubs for agricultural goods, precious and base metals and oil and gas products.
But the Asian countries have taken a decisive lead as importers and consumers of commodities – as measured by their growth, if not yet total consumption. Longer term, that will happen too. Asia has 60% of the world’s people, and some of its biggest infrastructural needs.
And the trading is being drawn to that magnet. In listed futures and options trading, 2001 was the year when Asia outstripped Europe, by volume of contracts traded (see graph at foot of this article).
At that time, the numbers were 109m contracts in Asia and 89m in Europe. North American volume was 182m contracts.
For the next seven years, the North American market grew every year, and stayed ahead of Asia. In 2009, North America stumbled, with a 3% contraction to 679m contracts. But even without that it would have been left far behind, as Asia stormed from 664m to 960m.
In 2010 another milestone has been passed: Asia now accounts for more than half of global commodity futures and options trades. Its total for the first seven months of this year, 682m contracts, was more than for the whole of 2008.
With tenfold growth in a decade, you might be forgiven for thinking the Asian commodity derivatives markets had realised their potential. Far from it, say market participants.
Just the beginning
For despite the huge total volumes, many of Asia’s commodity markets have underperformed their potential. Virtually all the growth has come from China and India, leaving a ring of markets on the Pacific seaboard, from Tokyo to Singapore, that are still small compared to the markets of the US and UK.
“Asia’s commodities markets have grown quickly but still have a lot of development potential,” believes Toby Lawson, managing director of Newedge Asia in Hong Kong.
That assessment is echoed by Geoff Howie, markets strategist at MF Global Singapore. He says that historically, Asia’s extensive demand has either flowed overseas or through the over-the-counter market.
“We see so many international trades flow to the US and Europe,” Howie says. However, he believes the local markets will grow, demonstrated by the fact that 85% of Asia’s energy requirements flow through the Asean market. That has contributed to Singapore becoming the largest OTC energy trading market in the world.
A different interpretation comes from Tom McMahon (pictured), chief executive officer of the soon-to-be-launched Singapore Mercantile Exchange and a former director of Nymex Asia.
“Liquidity for commodity derivatives traded in Asia already has presence and volumes on par with exchanges outside Asia,” he says.
Almost all the Asian commodity exchanges, McMahon argues, serve mainly domestic requirements, from raw commodity producers obliged to manage risk to multi-commodity traders seeking to protect their profits and find consumer markets.
“I think it is only natural,” McMahon believes, “that derivatives for trade flowing out of Asia should be traded in the Asian time zone and cleared through well-regulated hub exchanges based in the very same region and environment as the producers.”
Trading in bulk
Two markets where outflows of trade are not an issue are China and India. These tiger economies now lead Asia’s commodity derivatives trading volume.
Both markets are under severe regulatory constraints, which arguably both help and hinder the markets. In each country, firms wanting to hedge commodity exposure are obliged to use a domestic exchange. This gives the national bourses a monopoly of that demand.
On the other hand, foreign market participants are banned, cutting off a different source of liquidity.
The exchanges’ tremendous domestic success, however, has pushed them to the top of world commodity rankings.
In June, for example, the Shanghai Futures Exchange had the world’s three most actively traded metals contracts – its Zinc, Steel Rebar and Copper Cathode Futures.
International market participants are desperate to get involved, and both countries are likely to let down the barriers eventually – something that will probably lead volumes to soar. Just don’t expect that to happen too quickly, warns Lawson.
“There is no doubt that China is on the path to internationalisation but it is moving at its own pace,” he says.
Both nations are wary of derivatives, and of the potentially destabilising effects of foreign speculative inflows.
Kishore Narne, head of research at Anand Rathi Commodities in Mumbai, says movement towards foreign access in India is inching forwards. “India’s Forward Markets Commission has suggested the idea of allowing foreign participants to act as brokers without becoming directly involved in the market, but as yet no talks have begun,” Narne says.
Nevertheless, Lawson expects change to happen faster in India. “The internationalisation of China’s financial markets will take time,” he says. “China is not driven by political cycles and will move in a methodical fashion in opening its markets.”
A fast move
Still, China surprised many by the speed with which it opened up its new equity index derivative market to foreign participants. The country’s first listed financial derivatives for 10 years began trading on April 16 – and on May 26 a decision to allow Qualified Foreign Institutional Investors to use the contract was announced. However, no date has been set yet.
China is making cautious, but significant, steps forward in a related area: loosening its grip on the renminbi. At the end of July it scrapped restrictions on the use of renminbi in Hong Kong. Banks can now open accounts and make payments in the currency for any company, or offer investment products in renminbi to individuals. Then in mid-August China opened its domestic interbank market to foreign banks.
With or without foreign involvement, it looks certain that Indian and Chinese exchanges are headed for the very top in commodity trading.
Already, by number of contracts traded, Shanghai Futures Exchange is the world’s largest commodities exchange in 2010, with 265m bargains by the end of July.
Nymex is next with 246m, then Zhengzhou Commodity Exchange (225m), Dalian Commodity Exchange (142m), ICE Futures Europe (125m), Multi Commodity Exchange of India (115m), Chicago Board of Trade (106m) and London Metal Exchange (68m). India’s National Commodity & Derivatives Exchange is still some way behind on 21m.
These numbers do not capture the cash value of trading, but the trend is clear. And considering the pace of domestic economic growth, the prospect of liberalisation, and the still young nature of these markets, there is every reason to believe Chinese and Indian commodity exchanges are still are far from peaking.
Singapore gets its skates on
With China and India’s exchanges still confined to their domestic markets, exchanges in the smaller Asian countries have had space to renew their efforts in international commodity trading.
After taking over as chief executive of the Singapore Exchange in December, Magnus Böcker immediately moved to expand commodity trading at the exchange and its subsidiary, the Singapore Commodity Exchange.
SGX listed Fuel Oil 380 Centistokes Futures on February 22, while Sicom added Gold Futures on March 30 and Robusta Coffee on April 22.
In July, SGX struck a deal with the London Metal Exchange to list mini versions of the LME’s monthly metal futures, cash-settled against LME prices. Copper and zinc will come first, with steel billet derivatives later, subject to regulatory approval.
“These contracts will create increased trading, hedging and arbitraging opportunities at a time of strong interest in metals trading in Asia,” Böcker said at the end of July.
An executive at a futures commission merchant in Singapore welcomed SGX’s expansion of its commodity products, but said that perhaps its greatest chance of success would be to capitalise on Singapore’s extensive OTC energy derivatives trading.
Japan wakes up
Meanwhile, Japan is also seeking to begin the long climb back to the top echelons of global commodity trading.
Twenty years ago, Japan was home to nearly a fifth of global futures and options trading, with particular success in commodities. Since then, it has fallen far behind.
One obvious problem is that trading is split between the Tokyo Commodity Exchange, Tokyo Grain Exchange, Kansai Commodities Exchange and the Central Japan Commodity Exchange (C-Com).
Then an amendment to the Commodity Exchange Law in 2005 made it much harder for Japanese commodity exchanges to market to retail investors. Trading volumes have collapsed.
This year at last, some solutions have begun to emerge – notably, consolidation of the exchanges.
C-Com has announced that it will close its doors in early 2011. Tocom will take over its two main products, Gasoline and Kerosene Futures. Tocom has also declared an interest in “two or three” of TGE’s products.
But mergers could even go further than that. The government has drawn up a plan to unify derivative markets, which could lead to Tocom and the Osaka Securities Exchange being combined, although this has been denied by both parties.
Will this be enough to revitalise Japan’s commodities futures markets – especially now that so many more Asian markets are operating?
The market source in Singapore says anything is possible, especially given the significance of Japan’s economy, but that Japan’s exchanges must consolidate and become easily accessible to foreign participants.
Furthermore, he argues, the country must amend its tax system. At present, firms that have any trading infrastructure in Japan are taxable, at higher levels than in other countries.
Gleaming and new
While Asia’s old commodity markets have set their sights on recovering lost ground, a couple of new upstarts have emerged. The Singapore Mercantile Exchange has just gone live and Hong Kong Mercantile Exchange plans to later this year.
SMX is the new child of Indian exchange operator Financial Technologies. It opened its doors (or at least, electronic gateways) on August 31 with euro-denominated Brent-Euro Crude Oil Futures, West Texas Intermediate Crude Oil in US dollars, Gold Futures and Euro-US Dollar Futures. This portfolio of contracts is set to expand in the future.
HKMEx, meanwhile, plans to start with gold futures in US dollars.
Following slightly different strategies, SMX plans to offer commodities to a pan-Asian market, while HKMEx wants to be the bridge between mainland China and Asia.
So what hope for the two new exchanges? Offering futures on commodities that have an important trade in Asia has not always resulted in substantial volumes.
An example is robusta coffee. Vietnam and Indonesia are two of the largest global exporters, yet the vast majority of trading in robust coffee derivatives happens at Liffe in London.
So what’s the solution? Each of the new exchanges is counting on there being demand for an international commodity exchange in the Asian time zone, and relying on what it sees as its unique strengths.
HKMEx, for example, is proud that it can offer physical delivery of the underlying gold and silver at a purpose-built Precious Metals Depository at Hong Kong airport.
Howie says that for these two exchanges or the incumbents to succeed in listing a new contract, unique specifications are vital.
“Asia is a very niche market,” he argues. “The exchanges here have to put a product on that has some kind of niche that exchanges in Europe and the US don’t have. There are enough intricacies that products that suit the region can be developed.”
SMX seems to agree. “It is true that our initial suite of products is very successfully traded at other markets,” says McMahon, “but our contracts for these products are not plain vanilla; they are embedded with certain specifications which are unique to SMX or our regional clients. Our Gold Futures contract, for example, is Singapore’s first physically delivered gold futures contract.”
“The way to keep liquidity robust here in Asia,” McMahon adds, “is to have generic and niche products available on the same platform, with specialised contracts rolled out every now and then to plug requirements thrown up by the marketplace, thus putting collaterals to most use.”
Big now, bigger in the future
Predicting the financial markets is a minefield. But few seem in doubt that Asia will extend its lead as the largest exchange-traded commodity market in the world.
Unsurprisingly, as head of a nascent exchange, McMahon is bullish on the region’s prospects, especially those of Singapore.
“As more barriers within the Asian trading community fall, Singapore will by default always be several steps ahead in terms of infrastructure and a free trade marketplace,” he says. “As proxy to marketplaces in the West, Singapore has been leading the way also for decades already. On behalf of Asia, it would be logical for Singapore to be the leading exchange-traded commodity centre of the world.”
Lawson (pictured) says Asia’s growth trajectory suggests it will inevitably become the largest region in terms of share of world GDP. “However,” he cautions, “there are no certainties in economics and the chances of black swan events triggering a crisis remain a possiblity for a region that is still in a developing phase.”
Unforeseen crises aside, all the trends point one way. Sooner or later, Asia will dominate, not just as a growth driver for commodity production and consumption, not just with the biggest haul of futures and options contracts, but with the biggest world share in trading by value.
The big unknown is what slices of that huge pie the region’s many exchanges will manage to carve out.
Graph: Asia's big climb - global commodity futures and options volumes since 1980 Source: FOi