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Future of futures shanghaied

What's behind the soaring volumes of commodity derivatives?

The volume of commodity derivatives traded on the world's exchanges soared 27% in 2016 – mostly at the expense of equity derivatives. Sometimes an apparently insignificant news item disguises much larger and much more important trends. Conversely, it is also the case that too much can be read into events.

But with such a significant increase it is interesting to ask why?

Boring equities

Over recent years the absence of volatility in equity markets has made equity derivatives a bit dull for the average trader. This has been reflected in equity derivatives falling to from 72% of global derivatives volume in 2009 to 45% according to the World Federation of Exchanges annual report.

But boring equity derivatives alone cannot account for the bumper crop of commodity derivative contracts: their volumes have increased respectively by 57%, 27% and 13% in the EMEA, Asia-Pacific and the Americas.

The big change was in commodities futures, the number of contracts of which rose 28.5%

Why has there been this extraordinary rise in the volume of commodity derivative use?

Oil inflames

One reason may be that commodities have become a bit more exciting. The contracts recording the highest volumes were the Crude Oil Brent futures in the EMEA region, Crude Oil and Natural Gas futures in the Americas. However, it was Steel Rebar, Soyabean Meal and Iron Ore futures that turned on traders in the Asia-Pacific region.

The focus on oil products reflects the volatility and uncertainty in energy markets induced by Saudi Arabian oil production constraints that seemed aimed at scuppering the shale oil boom in the US. Seeking certainty of price and security of delivery of the real product will have played a part in derivative market activity.

The fact that the Dalian Commodity Exchange and the Shanghai Futures Exchange, two of the three exchanges that dominated the commodities derivatives market are in China (the third was the CME) reflects China's growing impact in international commodity finance.

But the high volumes of Steel Rebar and Iron Ore futures traded in the Asia-Pacific region may also have been a reaction to administrative uncertainty regarding domestic iron ore production and foundry capacity within China.

The other asset class

The particular and possible reasons for energy and iron ore to spur derivatives market activity does not account for the steady rise in commodity derivatives activity since at the same time as equity derivatives volume has slumped.

Volumes of traded commodity derivatives during the "commodity super cycle" were modest with traders probably working in the physical markets confident of demand and delivery.

Growing volumes, rather than being a transient phenomenon may suggest commodity derivatives are coming of age and will in future rank more equally alongside equity, interest rate and currency derivatives.

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