Banks gear up for iron ore trading

Three of the biggest banks in commodities plan to launch trading in iron ore, a further signal of the rapid growth of the mineral’s derivatives market amid disarray in the annual price negotiations. The move by Morgan Stanley, Goldman Sachs and Barclays Capital into cash-settled iron ore swaps comes as mining executives acknowledge openly that the traditional system of annual talks – known as the benchmark – to settle prices for the input to steel is breaking down.

The secretive negotiations are between Vale of Brazil, Rio Tinto and BHP Billiton and the steelmakers, led by Baosteel and the China Iron and Steel Association.

Traders said spot prices – physical and paper – could gain further importance if miners and steelmakers fail to reach an agreement for the 2009-10 prices, after missing an April 1 deadline. They said the possibility of a failure was growing.

The likelihood of a structural change to price iron ore sales based on spot prices rather than annual settlements comes a year after the launch of the first cash-settled ore swap by Credit Suisse and Deutsche Bank.

Among the banks, Morgan Stanley said it had started trading iron ore.
Barclays said it was “considering entering into the iron ore market in response to” its customers’ needs while bankers said Goldman Sachs was looking into ore, but added that its plans appeared less defined.
Goldman declined to comment.

Espen Aaboe, managing director of freight at Morgan Stanley in London, said that as the spot market for iron ore has evolved, Morgan has concluded that there are “opportunities” for both the bank and its clients. “It is clear that the benchmark system is undergoing change and that the long-term trend may be evolving towards a spot pricing market,”
he told the Financial Times.

Bankers and traders said Morgan was better positioned than others to profit from iron ore trading because of the linkages with its strong freight business.

The spot physical ore market last year saw transactions worth about 180m tonnes, up 50 per cent from 2007, and accounting for about a fifth of the total seaborne ore market, according to BHP Billiton.
Traders estimate about 18m tonnes of iron ore was traded on the derivatives, or paper, market in the past 12 months and say volumes could hit 30m-40m tonnes by the end of the year.

The paper market has been boosted after LCH.Clearnet, Europe’s largest independent clearing house, and Singapore Exchange announced that they would clear the swaps. The move is important because until now, buyers and sellers of the private, bilateral over the counter swaps bore the risk of their counterparties defaulting, deterring some potential
participants. Now that concern has been salved.

Ian Ashby, head of iron ore at BHP Billiton, said the market was following a natural evolution. He told an industry conference last week in Sydney: “Not only is iron ore now traded daily on the physical market, but also every day iron ore paper contracts are traded.”

Copyright The Financial Times Limited 2009

www.ft.com/cms/s/0/0445a55c-3e55-11de-9a6c-00144feabdc0.html

By Javier Blas, Commodities Correspondent

Published: May 11 2009 22:34 | Last updated: May 11 2009 22:34