China is looking to boost its role in global commodity markets by allowing foreign investors to trade iron ore futures on the Dalian Commodity Exchange from Friday, a move which should help the country gain some pricing power over the key ingredient in steel.
China is the world's largest importer and consumer of iron ore. It imported 1.08 billion tons of iron ore in 2017, accounting for 68 percent of total global shipments.
Allowing foreign players on to the exchange will help Dalian challenge the Singapore Exchange, which has established an international platform for iron ore trading.
Iron ore derivatives are the second Chinese commodity market that China has opened up to overseas investors.
Oil futures contracts started trading on the Shanghai Futures Exchange on March 26, and according to the commodity broker Marex Spectron, trading volume in the front-month contract has been 10 to 15 percent of that for the U.S. West Texas Intermediate benchmark.
How are the contracts designed?
The futures trading on the Chinese exchange will be priced and settled in Chinese yuan, but foreign participants are allowed to make deposits in U.S. dollars.
The Dalian Commodity Exchange, currently the only Chinese exchange offering iron ore futures contracts, issued draft rules last month to guide foreign investors who wish to participate in the market.
The guidelines say foreign investors can trade in the market through a futures-company member or through overseas brokers who entrust a futures-company member with the trading.
What are the concerns among foreign investors?
Many foreign investors have expressed interest in trading on the exchange, simply because of the size of the market, while some are opting to wait and see before entering.
Volatility and liquidity in the iron ore futures market are among the top concerns of foreign investors, while regulation-related concerns about China’s financial markets also create complications.
The unpredictable movements and increased volatility of the Chinese yuan add to the risks that foreign traders face in China.
Financial institutions and banks, which are already familiar with the Chinese markets, are most likely to jump in first.
No immediate changes to the status quo are expected after the opening, and it depends on how participants use the contracts for hedging or speculation.
China to redress the imbalance of power
Vale and Fortescue, along with Rio Tinto and BHP Billiton, account for more than 70 percent of global iron ore exports, most of which go to China.
In a market controlled by a handful of mining giants, there is limited bargaining power for steel mills, with Chinese steel firms particularly powerless because they are too dispersed and struggle to act collectively.
But the situation is improving as China continues to consolidate steel production by merging state-owned groups and cutting the number of small players.