Understanding financialization

Derivatives create a link between financial and physical markets through which the former may affect the latter. They may gradually change market organization, making commodity pricing centralized and financially intermediated.

A wave of mergers and buyouts in the 2000s turned leading commodity exchanges from non-profit utilities into large businesses owned by financial groups. Deregulation, low interest rates and trade tensions fuel an unprecedented surge of financial speculation in ever more commodities, whose pricing is pushed to financial markets regardless of the real economy’s needs and involvement in derivative trading.

Many academic studies have demonstrated how excessive speculation distorts commodity markets, exacerbates price volatility and damages the real economy.

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 speculators, a bane to everyone else

Market volatility

A boon to speculators, a bane to everyone else

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.

Back to basics

When uncertainty goes 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 the real economy

Sustainable by design

A forward pricing utility for the real economy

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