By John Browning / February 19, 2018 / www.metalbulletin.com /
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Domestic Chinese trading is preparing for a shake-up after the new International Energy Exchange (INE), a subsidiary of the Shanghai Futures Exchange (SHFE), has announced it will allow non-Chinese companies to trade crude oil futures contracts.
Following the release of a one-line statement from the China Securities Regulatory Commission (CSRC) on February 9 that announced the launch of domestic crude oil trading on March 26, a minor earthquake for the oil industry and in the medium term for all commodities took place. The INE has said non-Chinese companies will be allowed to participate in trading crude oil futures contracts, priced in RMB using USD as the initial margin.
The ability for foreign producers and consumers to execute hedging contracts on a domestic Chinese commodities exchange using RMB is a game changer. The development of the petro-yuan may be some years away, but for consumers and producers, investors and commodity arbitragers, the Chinese commodity futures markets are deep pools of liquidity that international traders have been clamoring to access for many years.
Some western media commentators have been less than enthusiastic about the prospects for the INE, claiming that the 1000 barrel contract size, potential delivery issues, the dominance of the Brent and WTI benchmarks and regulatory uncertainty could act as major headwinds.
Yet, looking beyond the INE, the Dalian Commodity Exchange (DCE) is currently conducting a nationwide consultation on proposed changes to its rulebook that follow the INE principles on foreign access.
Established in 1993, trading a total of 72 million lots in January, of which 27 million lots were iron ore, the DCE's foreign access rule changes have already received preliminary CSRC approval. Therefore subsequent to the INE launch in the first quarter, it is possible that the DCE will offer foreign access to its heavily traded flagship iron ore contract before the end of the second quarter.
At the DCE's presentation on foreign access on Monday February 12, the DCE said they are moving ahead as fast as possible with the launch, although no timetable was given.
Following these first steps, larger and more significant steps are likely to follow, and should the INE and DCE trade successfully it is possible to imagine that the SHFE will allow non-mainland access to its metals contracts within the next 12 months.
Up to this point, the default currency for the international commodity trade has been USD, the earthquake to which I refer is that monopoly in the process of being broken. As non-mainland companies will be able to hedge their RMB commodity exposures, there is no doubt that Chinese commodity producers and consumers will demand that non-Chinese companies offer to price in RMB.
The question for the London Metal Exchange is when access to the SHFE is permissioned, how much long-term producer-consumer hedging from China and throughout Southeast Asia will switch to an SHFE pricing basis, therefore lowering the oxygen of liquidity for LME exchange users. One has to imagine it may be a significant amount. Yet, it is not all doom and gloom for the LME because it is possible that significantly more traders will enter into the SHFE-LME arbitrage across all metals due to easier and fundamentally more efficient trading access.
There are a few events in business when one can look back and say, "after that, things were never the same." The launch of the INE is such an event. Maybe not for the oil industry immediately, but definitely for the waves of change that follow and are enabled by it.
John Browning is Managing Director and chief operating officer of BANDS Financial, a leading Hong Kong-based futures broker.
John.Browning@BANDSfinancial.com