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On October 24, the Singapore Exchange (SGX), the most popular clearing venue for the ex-China 62% Fe iron ore derivatives market, said that it would launch a suite of 58% Fe iron ore derivatives contracts settled on the Metal Bulletin Iron Ore Index for 58% Fe fines plus premium (MBIOI-58P) and a second index provider.

Exactly a month later, Chicago-based CME Group announced its imminent launch of a 58% Fe swaps product, pending clearance from the US Commodity Futures Trading Commission, the exchange said on Monday November 24.

The CME’s and SGX’s launches of these lower-grade hedging tools come at a crunch time for the market.

The 300 million tonnes-plus of 58% Fe iron ore traded in the seaborne market so far this year has accounted for a large proportion of the new supply which has entered the market this year.

The new tonnes in the market hit as Chinese steel demand growth started to weaken, prompted by a slowdown in the construction sector.

As the market tipped into oversupply, prices plummeted, dropping throughout the course of the year.

Prices are now just over $70 per tonne – around 45% below the level seen at the start of 2014, when it was $130 per tonne cfr China.

The right hedging tool
Brokers, traders and bankers said that the new lower-grade derivatives contracts could be just what was needed to hedge against the sort of price volatility seen over the past ten months.

“Previously, people used the 62% Fe contract to bet the movement of the iron ore market in general. They have experienced basis risk, as price variations are quite different in lower-grade ore. The 58% Fe contract will provide a better hedge for them,” a broker at Straits Financial told Steel First.

The 58% Fe swaps, options and futures offerings will mean that market participants can get a lot closer to a “perfect hedge” when normalising back from the 62% Fe contract.

“This will reduce the basis risk, and the price variation of the contract will be synchronised with that of physical products,” an iron ore trader in Singapore said.

The right support
When the 62% Fe iron ore derivatives market was launched by the SGX in 2008, the market makers behind the move were banks and, alongside them, major miner BHP Billiton as well as a clutch of international trading houses.

A large proportion of the highest profile banks involved in trading iron ore have stepped out of the commodities market entirely in the past two years. As a result, market participants said, the 58% Fe contract will garner initial support from a slightly different mix of market participants.

“Cargill, Glencore, Noble, trading companies in China and big banks will be the makers of the 58% Fe contract,” a bank source told Steel First.

A broker echoed this assertion and said that the trading houses responsible for a significant proportion of the seaborne trade will need to drive interest in the contract.

Miners which already trade iron ore swaps could also be interested in the contract, sources said, but they noted that there was little indication about which producers, major or minor, might be involved, because those active in the market traded their positions through banks.

New liquidity
One argument made by detractors of the 58% Fe contract has been that adding a new grade of derivative to the market will dilute liquidity from the established 62% Fe suite of prices.

Sources speaking to Steel First, however, said that splitting liquidity would not be an issue because of the strong increase in liquidity in the 62% Fe market this year. This now routinely averages traded volumes of 4 million tpd on the SGX and multiple times that on the yuan-denominated domestic Chinese contract offered by the Dalian Commodity Exchange.

“There’s enough liquidity in the 58% Fe market alone. We’re really not worried about it diverting the funds from 62% Fe,” a European iron ore trader said.

“On the contrary,” another iron ore broker based in Singapore said, “the new contract will open up new liquidity as general usage grows.”