China's commodity trading crackdown has long-term consequences

Is there a longer-term cost to be paid by China for its ongoing efforts to curb what the authorities in Beijing see as unjustified price spikes in commodity prices on the country's futures exchanges? Certainly it is becoming clear that the authorities are continuing to ramp up their campaign against the so-called hot money pumping up commodity prices, with new measures designed to cool price action in iron ore, steel and coal among others.
In recent weeks the Dalian and Zhengzhou commodity exchanges and the Shanghai Futures Exchange have all toughened trading requirements several times. The measures imposed include raising trading margins, hiking transaction fees and imposing trading limits. For example, the Dalian Commodity Exchange (DCE) lifted the trading margin for its coking coal and coke contracts three times within the space of week, ultimately taking it to 15 percent effective from November 11.
These measures are designed to cool speculative flows into commodity futures as Beijing becomes increasingly concerned about price spikes and the potential for bubbles in futures markets impacting on the real-world economy. DCE coking coal has dropped about 22 percent since its closing peak this year on November 14 to a close of 1,280 yuan ($186) a tonne on Tuesday, showing the measures to cool the market have had some impact.
But the contract is still some 126 percent higher than it was at the start of the year, which is perhaps a realistic reflection of the state of the market. Coking coal demand from China has been strong this year given higher-than-expected steel output and earlier steps by the authorities to limit domestic coal mining.
By comparison, free-on-board coking coal prices in Australia, the world's biggest exporter of the fuel mainly used to make steel, have quadrupled this year to more than $300 a tonne. Demand from China has outstripped supply available from an industry that has spent the last five years downsizing as prices fell from record highs in 2011. The coking coal price action this year underscores the dilemma facing the Chinese authorities.
While the overall increase for the year is a reflection of the global state of the market, the authorities would have been concerned about the rapid pace of the much of the year's gains, the bulk of which came in a frenzied two-month period from mid-September to mid-November.
The coking coal contract doubled from 855 yuan a tonne on September 13 to 1,644 yuan by November 14, a rally that prompted the ongoing measures to force speculators from the market. The problem is that every time the authorities change the rules in order to force a change in prices, they surrender some of their credibility as a safe, reliable destination for investors.
It's no secret that China, as the world's largest producer, consumer and importer of commodities, believes it should be centre-stage when it comes to trading and price-setting. To this end China has increasingly touted its exchanges as where the world should be heading, even if progress on some fronts has been slow. So far efforts to set up a viable crude oil trading hub have come to nothing. It's yet to be seen whether a state-backed commodity hub recently launched in Shanghai that aims to become the main Asian trading point for natural gas will take off.
China has had more success in establishing dynamic markets for steel, iron ore, coal and agricultural commodities such as soybeans. But exchanges like Dalian and Zhengzhou cater largely for Chinese retail investors, as well as smaller-scale trading firms. While not absent, larger companies and foreign banks and trading houses are less prevalent. Part of this may be because they aren't fully comfortable investing on exchanges where the rules can be - and are - changed frequently in order to meet desired official outcomes.
A Western bank or trading house would undoubtedly prefer to deal with the Singapore Exchange, where the rules are more constant and akin to other major global bourses, such as ICE and Nymex. In essence, ultimately the Chinese authorities are going to have to decide whether they want their commodity exchanges to be true global players, attracting a broad spectrum of users, or whether they should remain as sort of casinos for yield-chasing locals. Once that decision is made, appropriate regulations can be made, implemented and maintained. But as of now, every time the authorities change the rules for a short-term aim, they serve to remind investors why they should be cautious about trading commodities in China.