Shanghai rebar futures attract more Western trade

Mon Jan 16, 2012

* Citi, Noble, looking to trade Shanghai rebar
* Regulation, currency conversion limits cap growth
* Western investors hope China will loosen restrictions soon

LONDON, Jan 16 (Reuters) - A growing number of western market players are looking to trade steel rebar on the Shanghai Futures Exchange, attracted by high liquidity and exposure to the world's top steel market, although strict regulation is still tempering growth.

Banks such as Citi and steel and commodity traders such as Noble are among the financial and physical players now looking to trade rebar on the Shanghai Futures Exchange (SHFE).

French brokerage Newedge has set up a joint venture with Chinese financial conglomerate Citic Financial, which gained access this year for its customers to the steel rebar and other metals contracts traded on the Shanghai exchange.

"There is an ever increasing number of Western companies seeking access to trade Shanghai rebar and other Chinese exchange markets, which is often tempered due to the regulatory restrictions on non-Chinese companies," said Mike Frawley, global head of metals at the Newedge Group.

More than 1.6 billion tonnes of rebar traded on the Shanghai Futures Exchange in 2011, according to data from the exchange that include both sides of trades.

This dwarfs any steel derivative traded in the West, with the runner-up LME steel billet contract at less than 15 million tonnes traded last year and seeing declining interest.

Liquidity is an obvious advantage of the Asian steel contract over western steel derivatives, but there are also other factors that make this contract particularly alluring.

"It's a very good proxy to trade against iron ore, and it is also a great way to play the Chinese construction sector if you have a view on that," said Macquarie analyst Colin Hamilton.

Steel rebar is a finished long steel product used mainly in construction.

Increasing exposure of Western manufacturing companies to Chinese steel prices also provides an incentive.

"There are many European and U.S. companies, which are quite familiar with hedging, that are moving their operations to China, and they are sourcing metals there, benchmarked against the SHFE prices," said Standard Chartered global head of metals Jeremy East.

"So they need to hedge against this exchange and they look to their relationship banks such as Standard Chartered Bank for solutions. That is a common theme in Europe that we are seeing at the moment."

PLEASE, OPEN UP

Western participants' growth in this market, however, is being capped by China's strict regulation and limits on currency exchange.

The Chinese regulator does not make it easy for non-Chinese companies, financial players in particular, to trade on its commodity exchanges due to worries that high speculation levels could inflate prices.

To have access to a Chinese exchange, a non-Chinese company must set up a local non-financial entity, also known as a wholly owned foreign entity (WOFE).

Western companies that do not already have operations in China are not often willing to go through this process only to gain access to an exchange.

"Legal and regulatory hurdles are often more complex than many companies and investment funds are prepared to undertake," Frawley said.

Financing a new WOFE can also be challenging because currency conversion is restricted.

The yuan is not a freely tradable currency. There are limits on conversion that make it difficult for foreign companies to move money in and out of China.

Trading houses with operations in the country can get around this restriction by converting foreign currency into yuan and vice versa through import/export transactions, but for financial participants it is not as easy, traders and bankers said.

This is pushing some of those financial players that have access to the Chinese rebar contract to limit trading to their own book rather than to open it to clients, preferring to make a different use of the yuan they own.

"Customers can't margin because they can't get hold of yuan remimbi ... We have got a lot demand for remimbi, so we use it for (our own) proprietary trading or we lend it," said a banker at a major European bank.

Many say, however, that relatively soon the Chinese government will start to loosen regulations, opening up the doors to non-Chinese financial players and making yuan convertibility gradually easier.

"I think it is a market that will develop overtime, and it could be that the Chinese regulator will open the door to foreign financial institutions, although it is difficult to say when," East said.

News that Britain is teaming up with Hong Kong to secure London a top spot as an offshore trading centre for the Chinese currency certainly has propped up these hopes.

(sourced Reuters)