HKEX Report丨Global Experience of Commodity Futures

北大汇丰金融研究院 2021-01-21

Editor's Note

The commodity futures market serves different needs of hedgers and financial investors. Meanwhile, empirical evidences show that commodity futures could diversify investment portfolios by potentially giving higher returns and lower volatilities. However, mainland China’s commodity futures market serves the real economy not as effectively as its developed counterparts in the world. So, for the Mainland commodity futures market to better serve the real economy, the linkage between the Mainland spot and futures markets should be strengthened, and the Mainland futures market should have a greater pricing influence in the global market.

Author: Chief China Economist's Office, Hong Kong Exchanges and Clearing Limited

REPORT SUMMARY

A commodity futures contract is a standardised agreement traded on the exchange to buy or sell a predetermined amount of a commodity at a specific price on a specific date in the future. The global commodity futures market has demonstrated a close linkage with the spot market. In the US and the UK, major producers and consumers gathered for spot transactions and the futures market was then established to address the uncertainties on prices and timing of physical delivery. The prices of commodity futures, therefore, have become benchmark prices for spot transactions of commodities. Theoretically, commodity futures prices can be affected by spot market elements, including spot prices, interest rate, storage costs, contract tenor and potential benefits to use inventories for production. Empirical evidence showed that the global commodity futures market has a close linkage with the spot market and that linkage reflects economic fundamentals and market structure.

The commodity futures market serves different needs of hedgers and financial investors. Hedgers are key players in global commodity futures markets. They include commodity producers, consumers and trading firms who use commodity futures to hedge against adverse movements of commodity spot prices. The physical settlement of commodity futures through the global network of warehouses is key to the strong linkage between the spot and futures market as it provides a cost-effective way to obtain commodities for commercial uses. Financial investors treat commodity futures as an asset class for passive investment or active returns. Empirical evidences show that commodity futures could diversify investment portfolios by potentially giving higher returns and lower volatilities.

Mainland China’s commodity futures market serves the real economy not as effectively as its developed counterparts in the world. The spot commodity market in Mainland China is fragmented such that the transaction prices usually vary across regions without reference to the corresponding commodity futures prices. The price volatility in the Mainland commodity futures market may be high due to speculative trading activities, which would affect the effectiveness of hedging. Besides, the limited choices of warehouses for physical delivery of commodities may increase the costs of storage, transportation and import taxes and the narrow range of product and currency denomination may not meet the various business needs in the Mainland. These affect the effective linkage between the Mainland commodity spot and futures markets. China is the second largest economy and one of the largest producers and consumers of a number of key global commodities. However, the Mainland commodity futures market has limited global interaction such that onshore and offshore hedgers cannot sufficiently reflect their price views on the global and Mainland commodity futures markets respectively. This contributes to the price difference between the two markets.

For the Mainland commodity futures market to better serve the real economy, the linkage between the Mainland spot and futures markets should be strengthened, and the Mainland futures market should have a greater pricing influence in the global market. To achieve this end, a number of initiatives could be considered. The use of commodity futures prices as benchmark prices in the spot market could be facilitated by consolidating trading and enhancing trade transparency in the Mainland spot market. The deviation of futures prices from the underlying fundamentals due to excessive speculation and transportation costs could be reduced by enhancing market regulation and expanding the warehouse network. The business needs of various sectors could be met by widening the product range and currency denomination. Moreover, the Hong Kong market, being an international financial centre at the front-door of China, could take the role as a super-connector in the commodities sector to further increase the global interaction of the Mainland commodity futures market, thereby helping strengthen the Mainland commodity futures market to better serve the real economy.

FULL REPORT

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