The quality specification for the DCE iron ore futures contract is comparable to the standardised specification used on Platts IODEX. Delivery units are 100 metric tonnes per lot; the maximum size of the contract is 1,000 lots and the contract is listed monthly (for the most recent 12 consecutive months). The minimum margin is set at 5% of the contract value. The contract is denominated in renminbi (RMB) but U.S. dollars (USD) can be deposited for use as collateral and offshore RMB (a.k.a., Chinese yuan (CNY)) can be deposited and directly used to participate in the futures trading at a 1:1 ratio. By comparison with the INE crude oil contract, the DCE iron ore contract price is duty paid rather than a net price, and delivery under the iron ore contract includes both bonded and duty-paid delivery modes.
The DCE rules provide for two routes by which an overseas investor can access the DCE iron ore futures contract: as a client of a domestic futures firm in China that is a DCE member and as client of an overseas broker, who then trades through a domestic futures firm in China that is a DCE member. Both routes have certain advantages and disadvantages. To read more about this, please see the more detailed version of this alert (available here).
A key feature of the iron ore contract is that it provides for settlement by physical delivery. For futures traders trading iron ore on international exchanges outside China, this is a new feature. Overseas investors will be required to provide physical delivery via bonded warehouses if they allow their trading positions to mature. Overseas investors will need to familiarise themselves with the contract’s pricing mechanism. The contract pricing applies a system of premiums and discounts to the settlement price on the DCE, reflecting impurities in the iron ore that is delivered pursuant to the physical settlement. These are assessed during inspection at the delivery warehouse.
Currently, global iron ore prices are based on the futures contract listed on the Singapore Exchange (SGX). The USD-denominated iron ore swaps on the SGX have been favoured by miners and traders, while the DCE’s futures have historically been used primarily by Chinese mainland steel mills and domestic investors. China, as the world’s largest net importer of iron ore, is at the centre of the physical markets. The restrictions on access to trading on the DCE for overseas traders have allowed the SGX contract to be a proxy for the Chinese market for international investors. It is, however, likely that there will be demand from overseas investors for the DCE contract from the outset, which may have a knock-on effect on the SGX iron ore contract. That said, the DCE contract is unlikely to suit all market players and the SGX’s contract will continue to have demand, at least in the short to medium term.
The success of the INE’s crude oil contract and the DCE’s iron ore contract is expected to pave the way for further opening up of the commodities futures markets in China, which have previously been closed to overseas investors. As the DCE iron ore futures contract has more than three years’ trading history, high trading volumes and liquidity, it seems likely that the DCE’s contract will create further overseas investor interest in the Chinese commodities futures market.
Client Alert 2018-085
