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Taking the first step towards building a long-term commodities platform in China

Updated: 11 May 2017
Charles Li Direct Page
We are in the midst of a lot of festivities and insightful discussions this week for LME Asia Week, the fifth time we’ve brought together market players for the biggest annual commodities gathering in Asia. LME Asia Week has grown every year since we started it in 2013, and this year is even more special, because today we are hosting hundreds of guests at our new trading platform in Mainland China: the Qianhai Mercantile Exchange, or QME.

We decided long ago that it was important to build out our commodities business, first by purchasing the London Metal Exchange in 2012, launching new metals contracts on our Hong Kong platform, and now by building a new spot commodities market in Qianhai, Shenzhen. Our team has been working diligently for many months to make sure everything is ready, and we are stepping up our preparations to get the market ready for trading.

The QME has been a hot topic this week, with many people asking me about its core mission. To better understand the QME, it’s important to first get a snapshot of the Mainland’s commodities markets. China’s three futures markets are highly liquid and freely-traded, but are geared towards retail investors and speculators. They have very few contracts that get physically settled. Spot market users are spread out among hundreds of disparate, poorly-regulated and highly-fragmented trading platforms around the country. This is inefficient, and ultimately results in higher costs for industrial users. Furthermore, there is little convergence between the spot and futures prices, an imbalance between the OTC and exchange-traded markets and a disconnect between the physical market and financial services. On top of this, while China is the world’s largest producer and consumer of many different metals, it lacks commensurate pricing power in global markets.

We see an opportunity to address some of these issues, which can be a win-win for Mainland China and us at HKEX. We think we can do it because, at HKEX, and especially with our Shanghai and Shenzhen Stock Connects, we have deep experience working with Mainland authorities, regulators and market players. In addition, we have the LME, which has a rich heritage as the global leader in non-ferrous metals trading. We believe we can leverage these two key advantages to operate a successful spot commodities market that serves China’s real economy.

But we can’t just blindly copy the LME, because China has its own unique characteristics and challenges I mentioned earlier. So we want to leverage the LME to begin tackling some of China’s unique structural issues by building a new model that both fills a market vacuum and meets market needs. It will be a fair, open, transparent and well-regulated market that, unlike many other commodities platforms in China, will be geared towards institutions rather than retail investors or speculators, giving them more hedging options. We want to serve the physical economy, and eventually establish benchmark prices for China.

The long-term objective is to operate an efficient marketplace with streamlined operations to enable physical users to manage their risk and get commodities at a lower cost. It will also help narrow the gap between onshore and offshore pricing and begin giving China a larger influence in global commodities prices.

We have chosen to build our onshore commodities platform in Qianhai, a modern service industry zone in southern China’s Guangdong Province, which is only 50 kilometres away from our headquarters in Hong Kong. On top of its close proximity, the long-term cooperative relationship between Hong Kong and Guangdong businesses and absence of a central commodities market in southern China contributed to our decision to open in Qianhai.

Any new effort faces some challenges. I have been asked many times if this is a good time to enter the Mainland commodities market, because China is in the midst of a crackdown on commodities trading platforms. We have just gone through a period where a lot of leverage has been put into China’s markets, risk has grown, and some unscrupulous players have been taking advantage. Mainland authorities are now taking a growing interest in this area, and have been looking closely at the models of various trading venues.

As the Mainland evolves and opens, it will always be two steps forward and one step back. The liberalisation process takes time, and we need to be patient. Nevertheless, we welcome and fully support the crackdown, as the long-term effect will be a much healthier and robust market. We intend to continue working alongside the regulators in Mainland China, and hope to make QME the standard-bearer for a fair, transparent and efficient marketplace that can support the next phase of China’s development.

As for the exact launch time frame, we aren't too fussed. Whether it's a limited launch earlier or a larger and more comprehensive launch later, our main goal is to have this platform fulfill our long-term vision. Our initial success will be judged in many years, not in a few months.

With our credibility, resources, knowhow and risk management capability, we believe we can begin helping facilitate the convergence of the spot market in China, form a solid and reliable commodities platform to supplement the futures market, and build a stronger connection between the commodities market and the financial services market in the Mainland.

Over the long term, we will look at ways to connect the LME and QME, bringing the liquidity of the China and global markets together to create even more opportunities. A Commodities Connect with Mainland China is a matter of "when", not "if". The current situation in the Mainland commodities markets makes a Commodities Connect more sensitive for Chinese regulators, but we will continue our conversations and remain hopeful we'll secure a breakthrough.

QME is also an important step in our commodities strategy. Internationally, on the spot market front, we purchased the LME to give us instant credibility and know-how. In China, the QME is a project we are building from scratch to address that particular market's needs. In time, we’ll also explore the cross-listing of commodities derivatives as part of the Connect programme.

True global financial centres have multi-asset class capabilities, and the QME is our next big step in diversifying our business and is a strategic step in strengthening our city’s future as China’s international financial centre. As the 20th anniversary of the establishment of the Hong Kong Special Administrative Region approaches this summer, we’ve been doubling down on our efforts to grow Hong Kong beyond our core equities business.

Today was the first time our market partners got to see the QME Ring. In time, we hope the Ring becomes as important and influential to the commodities market in Mainland China as the LME Ring is to the rest of the world.

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