Tackling financialization

Financialization denotes the increasing role of financial firms, markets, motives in the economy and share in economic outcomes, typically through proliferation of increasingly complex financial instruments.

As commodity markets financialize,

  • Speculation eclipses hedging;
  • Price formation gets centralized and financially intermediated;
  • Market makers (suppliers and end-users) become price takers.

Commodity derivatives—futures, options, swaps—were invented to reduce market risk through harvesting and business cycles. They served this purpose until the 2000s, when deregulation and consolidation turned leading commodity exchanges from non-profit utilities into sprawling financial conglomerates.

Unlike hedging, speculative trading is not limited by production and consumption. The more derivatives are traded, the more money flows to exchanges, brokers and their patrons at the expense of wider economy.

Many academic studies have demonstrated how financialization distorts commodity markets, exacerbates price volatility and diverts resources from productive to speculative and rent-seeking activities.

United Nations analysis

The United Nations working paper on the last financial crisis and economic development draws the following conclusions:

“These effects of the financialization of commodity futures trading have made the functioning of commodity exchanges increasingly contentious.

They risk reducing the participation of commercial users, because commodity price risk hedging becomes more complex and expensive.

They also cause greater uncertainty about the reliability of signals emanating from the commodity exchanges with respect to making storage decisions and managing the price risk of market positions.

It has therefore become necessary to consider how the functioning of commodity futures exchanges could be improved so that they can continue to fulfill their role of providing reliable price signals to producers and consumers of primary commodities and contributing to a stable environment for development.”

Market volatility

A boon to speculative finance, a bane to productive economy

Market volatility

A boon to speculative finance, a bane to productive economy

Ferrous markets

In April 2016, following massive deregulation, trading in China’s steel and iron ore derivatives surged exponentially, with SHFE rebar and DCE iron ore futures becoming the 1st and the 3rd most-traded commodity futures globally. In doing so, they surpassed ICE Brent and NYMEX WTI oil futures, which had been the most-traded contracts for several decades. According to Bloomberg, the average holding of trading positions was less than 3 hours.

Daily trading volumes in SHFE rebar and DCE iron ore futures sometimes exceed China’s annual iron ore imports and all shares traded on its equity markets.

Since all financial markets are interconnected, no commodity exchange is insulated from speculative frenzies elsewhere.

The more “investors” pile in ferrous derivatives, the less our markets are driven by supply and demand fundamentals. The more our economy is dominated by finance, the more financial intermediaries profit from market uncertainty and push related services and agenda.

Back to basics

As uncertainty and complexity go up, forward pricing in commercial markets provides a simple alternative to financial derivatives.

Steel stakeholders may tackle financialization by

  • Keeping ferrous pricing decentralized;
  • Limiting financial participation to sufficient liquidity provision;
  • Aligning long-term interests of suppliers, end-users and service providers.

Our platform and ecosystem are built on these principles, taking risk management back to its roots.

Sustainable by design

A forward pricing utility for Real Economy

Sustainable by design

A forward pricing utility for Real Economy

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