Euromoney: Will SMX carve itself a niche?

Euromoney, September 2010

Singapore Mercantile Exchange, billed as the first pan-Asian multi-product commodity and currency derivatives exchange, rang its opening bell on August 31. The next question: will people use it?

CEO Thomas McMahon describes the rationale as so obvious “it was like a light switch flicking on.” Asia is the new home of world commodities demand and Singapore the natural hub to trade it: its Jurong Island is one of the densest oil refining areas in the world, and its port one of the busiest. SMX has kicked off with four futures contracts: gold, with physical delivery to vaults near Changi airport; crude oil, in both West Texas Intermediate and euro-denominated Brent form; and a single currency pair, euro against the US dollar.

While SMX can claim a first as a pan-Asian hub, Asia is no stranger to commodities exchanges themselves. The real action is in China, where the three domestic commodity exchanges are remarkably powerful for bourses in a country with no foreign involvement and major currency controls. The Zhengzhou Commodity Exchange’s sugar contract was the top agricultural future or option anywhere in the world in 2008 and is likely to be so again in 2010, with RMB13.78 trillion of trades in the first four months of the year alone; the Dalian Commodity Exchange’s soybean meal and soybean oil contracts both comfortably outpace their equivalents in Chicago; and the Shanghai Futures Exchange did the unthinkable last year by overtaking the London Metals Exchange in copper volumes, as well as being the world leader in natural rubber futures.

Elsewhere, domestic contracts have been appearing across Asia. Chicago Mercantile Exchange and Bursa Malaysia launched a dollar-denominated palm oil futures contract in May. India’s Multi Commodity Exchange has proven a success. And Singapore itself already has commodity futures, through the Singapore Commodity Exchange (Sicom), a subsidiary of Singapore Exchange; this offers coffee, fuel oil and gold futures (though the gold contract does not offer physical delivery as SMX will) and last month announced plans to introduce base metal contracts on copper, aluminium, zinc and nickel in a deal with the London Metal Exchange.

The premise of the exchange is that most of these exchanges are either not open markets, and that local businesses ought to be able to hedge their commodities and foreign currency transactions in Asia without having to trek to London, New York and Chicago. McMahon points out that many commodities are produced, shipped, stored and used within Asia, yet the markets for pricing them are elsewhere.

The example of Olam, the Singapore-based agricultural commodity supply chain group, is being mentioned a lot: an acknowledged leader in commodities from cashews to coffee to cotton, why should it be unable to hedge in its own time zone?

But SMX sees the challenge ahead. “Launching a contract doesn’t guarantee its success,” says Jignesh Shah, vice chairman of SMX and group chief executive of Financial Technologies, the Indian company that has built the exchange (an interesting subplot is that Singapore’s new exchange was developed and is owned by an Indian company). Hauling liquidity from established exchanges and persuading people to transact locally will define whether the new exchange thrives or fails.

Another issue is competition with the SGX: so far the contracts don’t overlap and the two insist they are complementary to one another, but how long can that remain the case? It’s also worth noting the new arrival in Raffles Place last month: the first overseas office of the London Metals Exchange.

Logically, though, it ought to work, and SMX has more products in the works, starting with two more currency pairs (US$/Australian dollar and US$/yen). Shah says it is considering contracts for coffee, pepper and palm oil, and says options will naturally follow. “Futures without options,” he says, “are like a dance without music.”