Analysis: ICE faces tough competition in iron ore swaps launch

IntercontinentalExchange Inc may struggle to wrest much business from Asian rival Singapore Exchange as U.S.-based ICE embarks on its latest push into the lucrative, 115-million-tonne market for iron ore swaps.

More than three years after the launch of its first iron ore derivative, the U.S. exchange expanded its offering with Monday's launch of two iron ore swap futures contracts.

The Atlanta-based exchange aims to capitalize on growing interest among U.S. investors in using iron ore derivatives as a play on China, the world's No. 1 consumer of the key ingredient in steelmaking.

But some traders say it will be a challenge to lure money away from an entrenched benchmark that has the support of the market's biggest traders.

"The general impression seems to be that the new ICE contracts will not make much of an impact. Although there is growing liquidity, volumes are still not high enough to be split (between exchanges)," said Lee Taylor, an iron ore broker at London Commodity Brokers.

SGX, which was the first to launch a cleared iron ore contract in 2009, has more than 90 percent of global volume, according to SGX and trader estimates.

Its proximity to China, the world's top iron ore importer, also represents a clear advantage for the Asian exchange.

However, there are factors in ICE's favor. For one, it may have a home advantage, although the relatively small size of the U.S. market limits potential gains.

With new rules forcing banks to use cleared markets rather than over-the-counter (OTC) derivatives, Wall Street banks may prefer to use a domestic exchange registered with the Commodity Futures Trading Commission (CFTC) as designated clearing organization, a requirement under Washington's Dodd-Frank Act.

"The expansion of ICE's iron ore offering could provide additional market access for some participants," said Mike McGovern, vice president for commodities at Citi.

U.S. firms, though, are estimated to account for less than 10 percent of global iron ore swaps.

"The only people who will look at ICE might be those who already do gas or other products with them. If they already have an ICE account, iron ore is just an extension," said a London-based trader, who uses SGX and CME to clear iron ore swaps and options respectively, and is not considering switching to ICE.

SGX is still awaiting CFTC registration as a designated clearing organization. It has said it will introduce on February 25 an iron ore futures contract, which unlike swap contracts should not be affected by U.S. regulation. The move is seen aimed at retaining its U.S. market share.

Iron ore swaps are used by some miners, steelmakers and traders to hedge their physical positions or by speculative investors who bet on prices for the key steel ingredient.

An iron ore player can use swaps to offset physical price exposure by taking an equal and opposite position in the paper market. Such instruments provide price certainty for the buyer and seller by setting a fixed price for a set time.

The OTC iron ore derivatives market started in 2008 and has grown significantly in the last few years as the global steel industry moved away from a decades-old system of negotiated annual contracts to mechanisms based on daily spot market assessments.


ICE may find stiff competition in the fledgling market closer to home too, traders said. Domestic rival CME Group has similar contracts, which have struggled against SGX's dominance.

CME's more liquid swap contract settled against The Steel Index (TSI) <.IO62-CNI=SI> saw about 3.5 million tonnes traded in 2012, against 109 million on SGX.

Although growing quickly, the global iron ore swaps market represents only about a tenth of the 1.1 billion tonnes of physical seaborne iron ore traded each year.

If liquidity does expand over the long term, the Chicago-based exchange's first-mover advantage may mean it benefits more from any migration, traders said. It was the first to launch an iron ore option contract, and already has a larger offering in the iron ore space, with two swaps and two option contracts.

"I think CME would be the first choice because a lot of people already have exposure to CME with the options and their contracts have been around longer," said a derivatives trader at a steel trading firm who uses the SGX and CME products.

Besides SGX, ICE and CME, other exchanges and clearers that ventured into the iron ore sector are the Singapore Mercantile Exchange, NOS Clearing and LCH.Clearnet.

ICE's first iron ore contracts have not attracted significant volume, market participants say, although ICE refrains from publishing volume data.

Its first iron ore derivative, a monthly swap future launched in late 2009, settles against the Platts 62 percent iron ore price, the prevalent assessment in physical iron ore transactions.

One of the exchange's new contracts will settle against TSI, which is more popular in financial transactions, and similar to contracts already traded on SGX and CME.

ICE's other new contract will be set against the difference between TSI and Platts, offering a spread trade opportunity. It is aimed at capturing rising liquidity in TSI and demand for hedging spreads or outright positions, an ICE spokeswoman said.

But with little to differentiate them from existing products and the market still in its infancy, challengers will have a tough time beating their Asian rival.

"SGX has continuously had other exchanges try to encourage liquidity away from it, but the market seems to have accepted it as the main source of flow," broker Taylor said.

(Editing by Josephine Mason and Dale Hudson)