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Catherine Ngai/MEDILL

Although the Shanghai Futures Exchange reported extraordinary growth in metals futures in the last month, Nick Ronalds, executive director of the Futures Industry Association Asia, said that numbers are deceiving.


Shanghai threatens Chicago, New York and London in domination of metals futures

by Catherine Ngai
April 20, 2010


The extraordinary growth of the Shanghai Futures Exchange has grabbed the attention of CME Group Inc., the London Metals Exchange and other exchanges that have traditionally dominated metals futures, despite Shanghai's trading only in China.

Shanghai Futures Exchange was ranked No. 1 in metals futures and options trading volume in 2009 by the Futures Industry Association, the U.S. trade association. By supplanting the London exchange, Shanghai signals that the continuing robust growth this year could make it a powerful leader in the world futures exchanges despite its brief 12-year existence.

Last month, Shanghai reported almost twice the tonnage in zinc futures – approximately 77 million – on the London exchange, which traded 41.2 million. Considering that London ranks zinc as its third largest contract, Shanghai’s rapid rise could mean a persage in an epic battle for power and market share.

The Shanghai exchange was formed in 1998 after a resurrection of the Chinese futures industry. Before that, China’s communist government suspended futures trading for 60 years and shut down more than 40 exchanges, that analysts cite as price manipulation.

To some, Shanghai’s rise is not surprising.

“The vast majority of growth in metals demand is coming by China,” said Gayle Berry, a commodity research analyst at Barclays Capital PLC in London, in an interview. In past research notes, Barclays includes a section on metals prices in Shanghai and Tokyo. “It has been far the most dominant force in the market in the last decade, and its share of global consumption is now the largest by any factor and for any individual country.”

The exchange currently offers futures and options on copper, aluminum, zinc, gold, steel rebar, natural rubber, steel wire rod and fuel oil.

Despite its lack of history, the Shanghai Futures Exchange has grown rapidly. Its newest contract, rebar, a steel reinforcement used in concrete, began trading in March 2009 and was ranked first by the FIA metals futures and options trading volume contracts, even higher than London exchange’s most active contract, primary aluminum futures.

“I think it’s really servicing the demand that’s already there,” said Josef Schroeter, president of CQG Inc., a multiplatform analytics company in Colorado that offers data services and electronic trading. “They have done the right things to invest in technology, they’ve done their homework in preparing their market and they’ve been fairly methodical in introducing new contracts.”

Although monthly volumes have skyrocketed at Shanghai, and in some cases, increased by 7400 times from last year, volumes alone do not indicate market share.  

“No measure of exchange size or even contract size is completely adequate,” said Nick Ronalds, executive director of Futures Industry Association Asia. “Volume tells you one thing, but it doesn’t tell you the size of the contract.”

Taking a closer look, contract sizes at the Shanghai Futures Exchange are somewhat smaller than those traded in London, New York or Chicago. While Shanghai reported approximately 9.1 million copper contracts traded last month, the lot size is one-fifth smaller that of London, which reported approximately 3 million contracts traded in the same month. Thus, the tonnage is higher in London, even if the contract volumes are lower.

This has always been an issue. They don’t adjust for size,” Ronalds said.

London Metals Exchange was ranked No. 1 in metals trade volume in 2008 by the Futures Industry Association. Its largest futures contract, high-grade primary aluminum, traded 4.1 million contracts last month. Its second largest contract, grade A copper, is also traded at the Shanghai exchange, though volumes are much smaller.

Although Shanghai exchange, also called SHFE, has overtaken London in tonnage for zinc, there’s another side of the story.

“It is worth noting that SHFE is purely a regional exchange whereas the LME produces global reference prices involving trade from Chile to China,” said Stephen White, business manager of corporate affairs at the London Metals Exchange, in an e-mail.

Some argue that the Chinese infrastructure is unstable and prices are in a bubble. Another argument against Shanghai is that traders are more speculators than hedgers who are trying to manage risk, White said. This allows them to increase volume because of the immense numbers of contracts bought and sold.

Schroeter doesn’t buy the argument.

That might have been an argument at one point in time. I don’t think that’s the case any more,” said Schroeter, who recently visited China and met with representatives from the exchanges. “I think that the Chinese . . . have an overwhelming amount of money they’re able to devout to technology and education. Now, it’s a matter of how we in the West can participate in the East and add value to it.”

Shanghai Futures Exchange declined to comment for this story. 

China is one of the fastest growing nations and is the world’s top consumer of copper. At the moment, only companies based in China or with a subsidiary there are allowed to trade at the Shanghai Futures Exchange.

However, analysts believe that this regulation will be eliminated and ultimately allow global players to trade at the online platform exchange.

The greatest debate, at this point, is when.

“I think that the Chinese are extremely methodical. They’re not in a hurry when foreign exchange has tried to push them or foreign traders have tried to push them,” Schroeter said. “The other thing is that they’re spending a lot of time in educating people on how to trade effectively. They’re creating an environment there that’s really conducive there to trade.”

Keming Liang, a research associate at the American Institute of Economic Research and a native of Shandong province in China, explained that the government creates the China-only barrier as a defense mechanism.  

I think the purpose of that could be protecting the local economy,” Liang said. “I think also, in a sense, that they could bring the foreign companies and have them work with Chinese companies and use foreign technology and more than management experience to promote Chinese companies.”

Shanghai is not a threat to Chicago’s dominance in the futures game – yet.

CME Group has a relatively small market share of metals futures, but a dominant control over 100-ounce gold sold at the COMEX, a division of the CME subsidiar, New York Mercantile Exchange. In March, it traded 4.4 million gold contracts, a total of 13.6 million kilograms. In contrast, Shanghai traded approximately 49,000 kilograms.

NYSE LIFFE has an even smaller U.S. market share of gold futures. It posted a 1.28 percent market share in the same contract last month.

CME Group has tried to keep in touch with the Shanghai exchange. There is a memorandum of understanding with Shanghai, designed to allow better understanding of each other’s markets.

Berry thinks that the growth in China might slow down in the next 10 years as has been in the past decade.

I think we’ve come through a very rapid growth phase in terms of industrial growth and metals consumption growth. It’s unlikely that very fast pace of growth is going to be sustained and indefinitely,” she said. “But the scale of the growth size of the country will continue to expand and become an even bigger player.”

Even though the Shanghai Futures Exchange is thriving in a closed environment, many agree that once the barriers are diminished, the growth of this exchange will be even greater.   

Will Acworth, editor of the Futures Industry Association's magazine, reasons that this will create a “true level playing field.”

Although the future remains unclear, Acworth said that traders in Chicago, New York, London and worldwide should pay attention to what’s happening in the East. 

“Even if the futures exchange is closed, the commodity itself moves across borders,” Acworth said.