Singapore 03/02/2016 - In a blog post on Wednesday, Charles Li, chief executive of Hong Kong Exchange and Clearing (HKEx) shed more light on the exchange’s ambitious plans to build a China mainland spot commodities trading platform that could become representative ‘China price’ benchmarks and to ‘financialise’ the London Metal Exchange.
HKEx had published its 2016-2018 strategic report in January, where it said it is exploring the development of a China mainland spot commodity trading and financing platform capable of 'physicalising' mainland market benchmarks.
HKEx intends to build a commodity spot market in China starting with base metals, an approach Li acknowledged was “bold and unconventional”.
The exchange is looking at China because Hong Kong is not capable of supporting a substantial commodities trading hub due to its size, location and border controls, while standard futures contract trading is strictly licensed and controlled in China, said Li.
Unlike the LME model, China’s domestic commodities futures markets are top-heavy, with commodities futures traded primarily by pure financial retail investors with limited physical settlement. As a result, daily trading volumes are multiples of open interest, he added.
“Although physical users reference their prices, they rarely participate in trading as they cannot easily make or take physical delivery,” he said.
Substantial service gaps also exist in China’s spot market infrastructure that the exchange is capable of filling, which could lay the foundation to build into a leading commodities exchange that is deeply rooted in the physical markets just like LME, he added.
In China, physical spot markets are highly fragmented, warehouse systems are not trusted, credit enhancements are unavailable, and financing is difficult to obtain and highly expensive, noted Li.
“Our plan is to leverage our experience in launching new initiatives with the Mainland to bring LME’s successful model there to create an effective spot trading platform, thereby 'physicalising' the Mainland’s commodities market,” he said.
“In time, the platform could generate a series of truly globally-influential and representative 'China price' benchmarks, and would provide a solid foundation for the sustained development of commodity futures trading either onshore or in Hong Kong.”
Li also shared more on HKEx’s plans to further 'financialise' the LME.
Compared with other commodities futures exchanges, participation by pure financial investors on the LME is still relatively small, said Li.
“So a key part of our strategic plan is to build a London-Hong Kong Connect so that a much higher level of participation by Asia financial investors, particularly from China, can be secured over the coming years. This is what we mean by saying we want to ‘financialise’ LME”, he added.
In the medium- to longer-term, the exchange intends to undertake preparatory work for “London-Hong Kong Connect”, a scheme that connects the LME and Hong Kong Futures Exchange (HKFE) more directly. Both exchanges are HKEx subsidiaries.
The scheme will initially focus on 'westbound' trading and clearing of LME products for HKFE participants. This will facilitate access to the LME for Mainland Qualified Domestic Individual Investors (QDII-2), as well as Asian corporates seeking to manage their international metals exposure.
Li also said that these goals are “ambitious” and will take a long time - probably more than the three years - to accomplish.
But once the initiatives are in place, Hong Kong will become more relevant to both the Chinese and international market users, and cement its position as a comprehensive financial centre across multiple asset classes, he said.
“I am pleased to say we have the plan in place, and we’re off to a good start,” he concluded.