Commodities Explained: Metals trading in China

Once already this year traders in London have been dragged out of bed at 1am when copper plunged in Shanghai. That could happen more often and to more drowsy Londoners as SHFE adds two new contracts — nickel and tin — that were long the preserve of the London Metal Exchange only.

Metals volumes on the SHFE, a commodities exchange which was launched in 1999, have been increasing over the past few years.

Last week’s launch of the new contracts takes its offerings in industrial metals to six, equal to those traded on the LME, the world’s largest centre of metals trading. The LME was bought by Hong Kong Exchanges and Clearing for £1.4bn in 2012.

Many traders believe the SHFE has now taken its place alongside New York Mercantile Exchange’s Comex and the LME as a key price centre for the world’s metals trade.

Do we really care about SHFE, or Chinese exchanges for that matter?

Daily liquidity on SHFE is surpassing that of the LME and Comex put together. The highest monthly trading volumes for copper and zinc last year were on the SHFE, according to Macquarie.

Chinese futures contracts were also the top four most traded metals contracts in the world last year, according to the Futures Industry Association. SHFE’s steel rebar contracts were the most traded, with volume up 38.9 per cent to a record level of 408m contracts. Iron ore futures on the Dalian Commodity exchange came in third.

Who trades on it?

Chinese futures companies and funds as well as foreign companies which have wholly-owned subsidiaries in China can also trade on the exchange through domestic brokers. Chinese smelters use the SHFE price as a basis to sell material to end users. With China being the world’s largest metals consumer, prices on the SHFE give a key indication of the state of the domestic market.

OK, volumes are big, but can the SHFE prices affect international markets?

The price difference, or spread between the SHFE and LME, is closely watched, allowing traders and investors with access to various exchanges to take advantage of arbitrage opportunities.

The introduction of night trading to the SHFE in late 2013 allows trading at the same time as exchanges in the US and Europe, giving Chinese funds and traders greater ability to influence the global price. It also allows instant arbitrage, the simultaneous buying and selling of different contracts to take advantage of price discrepancies.

Does pricing on the SHFE impact international physical flows?

Yes, the SHFE price influences physical movement of metal into and out of China. Physical metals traders respond to the difference between the LME and SHFE price to book contracts.

What does this mean for foreign investors?

At the end of last year, China’s securities regulator started a public consultation on foreign investors being able to trade Chinese futures contracts.

A crude oil contract will be the first one available to foreigners to trade directly and is likely to start this year. It will be run by a subsidiary of SHFE in the Shanghai free-trade zone.

Still, it may take time to build up confidence, since according to metals market participants one advantage of the LME is investors can rely on the UK legal system to settle contracts, which gives greater security.

This article is the tenth in an online series on commodities made easy. For more articles in the series go to our Flipboard page.

Further reading:
China funds become new force in global commodity trade
China derivatives push gathers steam

Additional reporting by Lucy Hornby