From the November 01, 2011 issue of Futures Magazine • Subscribe!

Commodity trading in Asia: Slow but steady

Commodity trading in Asia, or rather the lack of it, has been one of the great puzzles of the modern trading world. Asia, with 3 billion people, has become the world’s engine of commodity demand. In spite of this, the region has failed to establish a strong commodity exchange. The vacuum has allowed London, New York and Chicago to thrive as commodity trading hubs. Consequently, today we have a scenario where Asian-based analysts look at macroeconomic trends in the region to forecast demand for commodities but have to turn to places like Chicago and London to check prices. What makes the whole situation even more ironic is the world’s first commodity exchange — the Dojima Rice Exchange — was introduced by Japan back in 1697.

So what are the reasons for this mismatch between the growth of commodity trading and commodity exchanges in Asia?

1. Lack of liquidity because of regulatory barriers: The commodity exchanges of the two tiger economies in Asia – India and China, which now lead the region’s commodity derivatives trading by volume — are under stringent regulatory constraints. Consequently foreign market participants can’t trade on them. This has the dual effect of cutting off liquidity on these exchanges and encouraging trading at rival bourses in Chicago, New York and London. The fact that domestic bourses have a monopoly in the country as domestic firms have a regulatory obligation to use them didn’t make up for loss of liquidity for the better part of the last decade and stunted their growth.

2. Narrow view by regulators: As bizarre as this may sound, the regulatory authorities in Asia (read India & China) take different views on stock exchanges and commodity exchange. The former are considered a barometer of the country’s growth and can be opened to foreigners, mainly institutional investors. However, the sole purpose of the latter’s existence in the policymakers’ eyes is to hedge commodity exposure for domestic firms. Consequently the growth and development of commodity exchanges in Asia never has been a matter of concern for regulators as long as they were fulfilling "their role" of hedging.

But all of this is changing fast. There have been significant developments in commodity trading infrastructure (both physically and regulatory) in Asia over the last few years. It is apparent that the pace of growth would have been faster had the global financial crisis not hit us in 2008. Asian countries became weary of derivatives and began trading slowly. India in particular feared inflation in commodities and, like some politicians in the United States, blamed markets and speculators and successfully restricted them. The effect on the stock markets of foreign speculative inflows (known as "hot money") taking "flight to safety" made Asian regulators more jittery.

So who will be the key players in commodity trading in Asia over the next decade?

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