Leading the Way

The launch of glass futures highlights a crucial step in the development of China’s financial derivatives By Lan Xinzhen

Speculators have recently been fixated on the share price of Luoyang Glass.The attention has put a strain on its chief executive officer Song Jianming, who is afraid that unusual fluctuations in the trading of shares will affect normal operations.

The State Council has approved the launch of glass futures trading at the Zhengzhou Commodity Exchange. In the past month, almost all the listed glass manufacturers, except Luoyang Glass, have undergone fluctuations triggered by rumors about glass futures.

Different from these glass manufacturers, the Zhengzhou Commodity Exchange is mainly concerned with whether the trading system of glass futures is viable.

Since the start of China’s futures market in the 1990s, China has followed on the heels of developed countries. By the first half of 2012,China had launched 26 futures products, encompassing bulk stock and agricultural products.

Lu Yong, an analyst from Guodu Futures,suggested that the launch of the world’s fi rst glass futures will have a signi fi cant impact on the glass industry and even the futures market.

The trading of glass futures in Zhengzhou Commodity Exchange would play a guiding role in the pricing of glass both at home and abroad.

Innovation

Lu believes the release of glass futures indicates that China has independent views on the development of fi nancial derivatives. Instead of targeting exclusively the most prominent investors, the contract unit of glass futures is fixed at 20 tons, making it more convenient for all investors to complete transactions.

Even though there are as many as 3,400 glass companies in China, most distributors and deep-processing enterprises are very small. A large contract size will undoubtedly force small and medium-sized glass enterprises out of the futures market.

Moreover, it is more convenient for carriers to transport glass products and for investors to make deals. Trucks and railways are the most frequently employed means of transportation in the glass industry, and the loading capacities of trucks and railway wagons are 40 tons and 60-70 tons respectively.

In this sense, the contract size of 20 tons is reasonable. Furthermore, the average price of glass has been 2,000 yuan ($321)per ton in the last two years, and if the security deposit of 10 percent is included—the highest rate required by futures firms—the price rises to 4,000 yuan($642)to trade one contract unit, which enables the glass futures to attract investors on a more extensive scale.

Moreover, deals can be reached without transporting glass products to third-party warehouses. As glass products are fragile and large in surface area, it’s dif fi cult to fi nd glass warehouses.

Factory delivery can better meet the purchasers’ needs. Since downstream glass fi rms always make purchases according to orders,factory warehouses can supply them with products of various speci fi cations.

Files from the Zhengzhou Commodity Exchange also suggest the new trading pattern allows purchasers to take delivery of glass products directly from the factory, signi fi cantly cutting transportation and loading costs and avoiding possible damage to glass products.

Pricing power

China has ranked fi rst place in plate glass output for 23 straight years. Will the first glass futures give China a leg up in gaining pricing power?

According to a study by Zhang Yumin, an analyst from Minmetals Futures, the top 10 glass manufacturers in China only account for 39 percent of the total, a relatively low rate of industrial concentration. The eastern regions control 86 percent of the total plate glass capacity, highlighting serious market segmentation.

Therefore, while China is the largest glass manufacturer in the world, segmentation has weakened its clout, hindering its ability to gain pricing power. The launch of glass futures will improve the pricing mechanism of glass products.

IN THE WORKSHOP:A worker checks glass products at a Fuzhoubased glass company in Fujian Province on April 8, 2011

The glass industry is sensitive to ups and downs in the real estate and automobile industries. Currently, excessive production capacity together with real estate regulation policies have had a negative impact on the development of the glass industry. Glass futures will not only give manufacturers access to hedging, but also smooth price fl uctuations.

In the past decade, an array of important raw materials and industrial products like aluminum, zinc and steel have been listed on the Chinese futures market.

These futures have complete cash markets and industrial chains, laying a solid foundation for the futures market to play a role in guiding the market price.

Some analysts take a different stance,arguing that the trading of some futures products like coke futures is still con fi ned to people engaged in the fi nancial industry, without listed companies in the trade involved,which has a limited impact on the physical market.

The same is true of glass futures.Participation of intermediary fi nancial institutions alone is far from enough to sustain the development of the glass futures because the price is not decided by the market but by speculators. However, listed glass enterprises still show little interest in futures trading.

Serving the real economy

The report from the China Futures Association stated, “Currently, China’s economic development has entered an important stage of industrialization. Surges in demand for raw materials in combination with drastic price fl uctuations are pressing entity enterprises to seek risk management, which requires us to allocate resources rationally and further strive for a louder voice in deciding the price of staple commodities.”

The Chinese Government hopes to push the development of the futures market in an innovative way in order to better serve the real economy. The intention grows more evident with the unveiling of glass futures.

Amid the global economic slowdown and waves of economic structural adjustments in various countries, China’s futures market should constantly improve its innovation capacity, speed up the steps of internationalization and intensify price risk management in particular to help enterprises set up brand superiority.

There have been dozens of cases illustrating how the futures market successfully serves the physical market. Corn futures released by the Dalian Commodity Exchange in 2004 has signi fi cantly stabilized the market and promoted the futures’ transaction size.

By now, corn futures have played an indispensable role in guiding farmers and agricultural enterprises to arrange production,adjust planting con fi guration, draw up marketing plans and secure expected profits. Many corn deep-processing and feedstuff enterprises manage to avoid price risks by participating in corn futures trades.

Trading Volume

In the fi rst 10 months of 2012, the total futures trade volume was 135 trillion yuan ($21.67 trillion), up 18.84 percent year on year.

In 2011, the total futures trade volume was 137.51 trillion yuan ($22.07 trillion),down 11 percent year on year.

In 2010, the total futures trade volume was 309.12 trillion yuan ($49.61 trillion),up 136.95 percent year on year.

In 2009, the total futures trade volume hit 130.51 trillion yuan ($20.95 trillion),up 81.48 percent year on year.

In 2008, the total futures trade volume was 71.91 trillion yuan ($11.54 trillion),up 75.52 percent year on year.

(Source:China Futures Association)

Since the Shanghai Futures Exchange launched copper futures in 1993, it has acted as an effective tool for enterprises to hedge price risks, bringing great changes to the pricing model in the cash market. Now, copper futures have evolved into the most mature and widely used category in China’s commodity futures market.

Files from China Futures Association suggest that China’s futures market has already opened up to overseas enterprises to engage in domestic futures trading.

In the future, China will undergo further domestic restructuring, continue its openingup strategy and face fiercer competition for pricing powers. For this reason, China’s futures market has to accelerate innovation in market supervision and promote institutional investment.

The government should release more agricultural commodity futures like crude oil,iron ore, rapeseed, egg, wood fi berboard and potato, which may better solve problems related to agriculture and push the development of the economy.