Early in May, the Chicago Mercantile Exchange (CME Group)
moved the first steel billet swaps cleared by a U.S. exchange,
the latest expansion of risk-management tools in global iron
and steel. The CME confirmed that it cleared 6,000 tonnes in
one trade and 3,000 tonnes in another. The broker of the first
trade was Freight Investor Services Ltd., and it was split over
the third and fourth quarters of 2012, which equates to 1,000
tonnes per month from July to December. Deutsche Bank AG
confirmed another partys involvement but declined to
Steel is widely considered to be the last major global
commodity to be actively traded under both physical-delivery
and cash-settled contracts. The CME Group and the London Metal
Exchange introduced contracts in late 2008 and early 2009.
Total volumes and the number of contracts and participants have
grown slowly, but both exchanges say they are pleased with the
progress and are developing new instruments.
The CME Group started with an indexed contract against
Midwest hot-rolled coil, while the LME offered billet contracts
and stuck with its tradition of physical business. The CME
billet contract marks an important expansion for the market,
but it also presents a more direct challenge to its competitor
across the Atlantic, which is evaluating a financial steel
offering but is a year or two away from bringing anything
Separately, other exchanges are being developed with the
intent of adding new hedging vehicles. The entire global
enterprise has had its growing pains, not the least of which
was the collapse of brokerage MF Global at the end of 2011. MF
Global was not directly tied to any of the exchanges, but it
was an active participant in steel hedging and its withdrawal
from daily business was a blow to the market financially as
well as psychologically.
Steel is one of the last commodities that does not have a
derivative contract, said James Oliver, senior director
of metals for CME Group Inc., owner of the CME. One of
the primary challenges is that there are so many types and
grades that it is difficult to determine against which of them
to settle a contract. When it comes down to what mills actually
produce, steel is a finished product and not really a standard
commodity. Another problem is that it is difficult to store
because it rusts so readily.
For all those reasons, the CME Group chose to lead with a
financially settled contract rather than on a physical-delivery
basis. Once the contract was on the market, however, it
has been a huge educational challenge, first to let the
industry know that these tools are available and then to show
them how to use them, Oliver said. The steel
industry has been around for decades, through good times and
bad. They have survived, but it is a very cyclical
The CME Groups full portfolio of contracts is
integrated into what the exchange calls a virtual steel mill.
We have Midwest and European (hot-rolled coil) as well as
billet, and also ore, coal, scrap, freight and (foreign
exchange markets) on one platform, he said. It
gives industry participants at all levels the opportunity to
hedge inputs and outputs to the extent that they need
Still, Oliver acknowledged that the educational challenge
remains. I go to conferences, and one of the things I
hear people talk about the most is volatility, he said.
They wonder what to do. But they already hedge zinc and
nickel. Eventually, they will become comfortable doing the same
with steel up and down the supply chain.
Just a year ago, the LMEs physical steel billet
contract earned the Best Product Innovation award at
AMMs Awards for Steel Excellence. Since then,
the LME has introduced swap contracts for all nonferrous metals
except cobalt and molybdenum, and hopes to have a steel swap
ready before the end of this year.
The CME Group and the Singapore Mercantile Exchange also are
in the process of developing new instruments, both physical and
financial, to increase volumes and liquidity in risk
management. But the established global markets are increasingly
being challenged by newer exchanges.
While the growth in steel and iron hedging opportunities are
accelerating, the growth is coming from a relatively recent
start. The reasons are many and varied, but chief among them
are the vast number of grades and types of steel, the reliance
of big mills on long-term contracts, and the fragmented,
national or regional nature of the business. All of those
factors are changing with increasing velocity, and the outlook
now is for growth in physical and financial contracts and
exchanges, perhaps for several years, followed by consolidation
as the global industry coalesces around the contracts and
exchanges that are most economical and effective.
The LME steel contract is relatively new, having been
introduced in 2008, Chris Evans, head of business
development for the LME, said. But we have had a long
association with the steel market through our trading in zinc
and nickel. The LME was founded in 1877, and its first
contract was for tin. Mills have been able to hedge input
costs for years, but theyand their customerscan now
manage the volatility at the other end of the supply chain.
With the LME that is billet, while exchanges such as CME are
focusing on HRC.
Evans further differentiates the LME contract from that of the
CME Groups hot-rolled coil contract, with the LME
focusing more on long products and the CME focusing on
flat-rolled contracts. The global industry is going to
need all of these contracts, he said. The existing
products are still finding their feet, and there is space for
more. It will take time for the industry to embrace these new
tools, but the last few years have demonstrated clearly to
mills and to their shareholders the benefits of active risk
There is a small irony in the current focus on supplementing
physical delivery with cash settlements: When the LME was
developing the first steel contracts in 2008, the initial idea
was for an index-based financial settlement. We had a
change of heart from that, Evans said. The strength
of our exchange is our physical delivery and storage model, and
our members were familiar with that method of
More to the point, there was some question four or five
years ago if the steel indexes available at the time were
suitable. The idea of selling on a formula linked to an
index was in its infancy, Evans said. We did not
think that the indices out there were robust enough for us to
use. Now those indices have come a long way, and if we were to
develop further contracts from our billets we would certainly
Evans is circumspect about the next few steps as further
additions to the steel market play out against the bigger
picture of the LME developing its own internal clearing house.
The exchange began work on that project late last year and has
said the effort could take as long as two years.
In the even-bigger picture, the whole LME is in play.
According to a statement the exchange issued in May, The
board has received a number of detailed proposals from
shortlisted parties in line with the process being conducted on
its behalf by Moelis & Co. The board will now consider the
proposals and provide shareholders with further information as
appropriate. The discussions shareholders have held with the
LME and its financial advisors during the process have drawn
out issues of importance to users of the exchange. The board
welcomes all input and will engage in further dialogue with the
LMEs shareholders to reach the best possible outcome for
In any case, there is an interest in new offerings but there
is no great rush, Evans said. We are seeing the slow
evolution of a large and relatively conservative industry. The
breakthrough will come when management realizes that by using
steel futures to lock in their costs and sales prices they can
offer better customer service and better returns to
shareholders. That gives them an edge over their competitors
and provides steady income flow.
Historically, Evans said, steel was a protected industry in
most countries because steel is a strategic resource and
because mills and mines were major employers. Now the
challenge to the companies in Europe and the Americas is that
governments there have run out of money but competitors in
China are still able to access state funds. To compete that
means that non Chinese companies have to be smarter, do
business differently, and manage better.
As the established exchanges develop new contracts, new
exchanges also are coming into being. One is the Cleartrade
Exchange, which handles over-the-counter swap contracts out of
Singapore. The exchange, which was created in 2010, works only
on a cash-settlement basis. The primary ferrous contract is a
62-percent fine iron ore swap that is settled against the Steel
Indexs global index.
Late last year, Cleartrade reported that since it launched
its China steel indices, uptake and regular usage by
clients and the trading of lots through LCH.Clearnet have
demonstrated that the market considers this a valuable service.
The China domestic hot-rolled coil and hot-rolled ribbed bar
markets are leading the way, while the iron ore volumes are
China is still relentless in its consumption of steel
and iron ore and is set to import more than two-thirds of
global seaborne iron ore this year, Ray Ang,
Cleartrades operations director, said. Currently,
our China steel index is the only China-based steel index which
is based on domestic spot steel transactions within China which
allows overseas participants to trade and clear.
The next contract to be added will be a U.S. hot-rolled coil
swap, which is pending regulatory approval and could be on the
market in a few months, said Richard Baker, chief executive
officer of exchange owner Cleartrade Exchange Pte Ltd., who
added that the contracts are already being traded
privately by brokers. To fill out the exchanges
ferrous portfolio, he also is evaluating such swaps as north
and south European hot-rolled coil as well as Turkish scrap.
Any new contracts would adhere to the cash-settled swap
Business mostly is among brokers and suppliers, but Baker
said that some mills are beginning to be active in iron
ore. They are still not very active in steel contracts. That
segment of the market remains an ongoing challenge to all
exchanges in 2012. For inbound commodities to the mills, the
banks and the brokers are using hedges extensively. For
outbound commodities from the mills, we see mostly end-users,
but that side is still very slow.
Baker acknowledged that while there is some hesitancy by big
mills to move into the derivatives market, there also is mixed
opinion in the trading community about the growth of many
different instruments and exchanges. The big exchanges
list multiple contracts, but some of them just never
trade, he said. They take the approach that if you
build it, they will come. We dont have that scale, so we
build specifically to a market need.
That said, he also understands that, with at least 90
percent of the global iron ore market concentrated in
Singapore, a new house has its work cut out for it to
attract that open interest. There is certainly room for more,
and we are seeing sustained growth.
Among users, its a buyers market during this
growth phase of steel futures and options. The derivative
markets were really developed to help manage price volatility,
but what each market needs is industry participation,
said Rick Dougherty, vice president of sales and marketing for
Cargill Inc.s Cargill Ferrous International, a major
global trader up and down the steel supply chain.
Ultimately, the exchanges need volume and liquidity to
thrive, Dougherty said. We look at each one, and at the
moment they all seem to be growing in dollar volume, in number
of contracts and in number of participants. It just takes time
for people to get comfortable with these tools and these
markets. They are definitely helping the industry and will
continue to do so.
For all the fecundity of steel futures, Robert McCutcheon,
head of U.S. metals and industrial products at
PricewaterhouseCoopers, said that steel and iron hedging today
is where aluminum and copper were decades ago. He agreed that
there is truth in the claim that there is high variability in
the finished product, but he thinks the slow development of a
forward market is more a matter of steel being viewed as a
national resource as well as being a regional market.
There are pros and cons to each exchange, he
said. To some degree, they take control out of the hands
of the producers, and they are reluctant to let that go. The
mills want to set the price, not necessarily do business based
on an exchange- or index-based price.
McCutcheon said that the growing sophistication of
commercially available risk-management software is driving
interest in forward markets. There are highly developed
commodity-trading and risk-management packages out there,
capable of tracking and integrating many different trading
instruments, he said. But those instruments are
only as good as their liquidity.
Risk managers at mines and mills are looking at all the
different ways of structuring their contracts, McCutcheon said.
It is much easier to use derivatives because you can go
back to the market every day and adjust your hedge position
based on where your physical position is. But it is hard to go
back to your suppliers and customers and try to renegotiate
those contracts. That is the challenge: balancing your fixed
vs. your variable exposures.
Ultimately, McCutcheon said, steel remains a highly
fragmented market in terms of finished material as well as
geographically and competitively. Look at the top five or
10 largest types of steel coming out of the mills, and look at
their cumulative volume as a fraction of the whole industry.
Now look at the top five or 10 types of ore or aluminum,
he said. You see how fragmented steel is.
Over the next few years, new contracts and new exchanges
will continue to be launched, which will be followed by a
period of consolidation as the industry reaches consensus on
the most economical and effective types of derivatives,
McCutcheon said. Look back at aluminum. How long did it
take us to get where were are?
We are seeing good, broad participation in the billet
contract, Evans said. The merchants tend to be
first in these situations, but the mills are participating. By
participating in the market, we are requiring companies to
think carefully about how they do business, and how they can do