NEW YORK Steel derivatives continue to face an uphill battle as concerns over illiquidity and price risk keep some would-be participants on the sidelines, but advocates of the nascent products maintain swaps and futures will find a place in the global steel sector yet.
Once the realm of energy, agriculture and base metals, the futures markets have been expanded in recent years to encompass six steel productsincluding hot-rolled coil, rebar and billetas well as a number of related raw materials, from iron ore to ferrous scrap.
Although some steel derivatives have started to see tractionwith the newest product, CME Groups No. 1 busheling futures contract financially settled against AMMs Midwest Scrap Index, trading more than 3,000 tons in its first full month in existenceothers have been slow to gain acceptance in the marketplace.
"In the U.S., we have a lot of difficulty with our steel community. They generally are not inclined to be educated about the history of financial derivatives in this country. They read headlines, and the headlines talk about a rogue trader in London ... and they figure they shouldnt be involved in it," Jeremy Flack, founder and president of Cleveland-based steel distributor Flack Steel Ltd., said during a steel swaps webinar hosted by London-based Freight Investor Services Ltd. (FIS). "We spend a lot of time here just getting people not to be afraid. There are a lot of misconceptions."
According to Flackwhose company has been vocal in its belief that service centers should offer hedging services alongside cutting and slittingsaid the misconceptions surrounding the use of steel derivatives largely stems from a belief that hedging introduces more risk into a companys trading book.
"(One) misconception is if I lock in a price and the price goes down, I could lose. (But) if used correctly, youre taking risk out of the equation," he said. "Youre not going to get rid of volatility in hot-rolled coil. The price itself is not going to stop being volatile if you engage in using these instruments, (but) youll just take some price risk out of your own business. We think the small price for the vaccine is nothing compared to the benefit of being vaccinated."
Phillip Price, structured products manager at Stemcor Risk Management AG, Zug, Switzerland, a unit of London-based trading house Stemcor Ltd., agreed that the use of futures offers a net benefit.
"If you have any possibility to build in the use on long-term contracts or even short-term contracts where pricing is linked to an index, it greatly enhances your ability to manage risk. It also gives you the ability to have much greater forward visibility of your business on a day-by-day basis," he said.
But despite its proponents insistence, many physical market participantsparticularly steel millscontinue to eye the fledgling products with caution.
Part of that concern is tied to liquidity concerns, FIS steel derivatives broker Sam Mehew said. "The steel industry is so much more fragmented than the iron ore market. Weve got about six traded steel products out there at the moment, whereas iron ore has only one focus. So the nature of it is all the liquidity is spread a little bit thinly across all the six contracts. Im afraid thats the nature of the beast, really," he said.
Nonetheless, advocates maintain that the tide is turning.
"Were starting to see liquidity come in on the contracts and they are building, but they are a nascent market and weve got to start somewhere. Its growing, and were pleased to see the growth so far," Mehew said.
Flack agreed, noting that as more regional banks and trading desks push to get their clients involved in hedging, the products are expected to really take off. "At some point, this market is going to take off like the oil market, like the aluminum market, and you dont want to get left behind," he said.