HEAVY3 crop.JPGShanghai's futures exchange (SHFE) plans to offer China's first steel futures contract and options on copper futures before next year.

No prizes for guessing why. Two decades ago, steel trading in China was determined by government allocation. Today, China's steel users find themselves at the mercy of a global commodities boom and inefficient local supply chains.

The solution, according to Li Yaoqiang, president of China's national association of metal traders, is to create a less “irrational” system in which users have a greater say in pricing and can access a risk-hedging mechanism, such as SHFE's putative steel futures contract.

Steel prices in China have suffered from dramatic rises and falls in recent years and the fragmented local industry has long struggled to better match supply to demand and keep a lid on surging iron ore prices.

Steel prices, at least, have some connection with reality. Unlike copper. The price of the reddish metal has doubled this year but physical demand has not. Veteran traders say the market is heading for a crash because the price is driven by speculators rather than fundamentals.

Perhaps the last thing the copper industry needs is another way for speculators play the market.

No matter. SHFE's new copper options add to the growing range of contracts that can be traded locally in China's three futures exchanges and show derivatives have regained the respectability they lost in China in the 1990s after trading scandals.

The growth of fledgling China's derivatives markets creates big opportunities for western firms. It started with commodity contracts, but last year's revaluation of the yuan has created a new demand for derivatives to manage currency risk.

A watershed moment came last December when Tullet Prebon opened China's first interdealer broker in Shanghai. Tullet Prebon is the world's second largest IDB and deals in a wide range of products, including fixed-income securities and derivatives, interest rate derivatives, equities and energy.

In China, it has set up a 33:67 JV with Shanghai International Trust and Investment Corporation (SITICO).

The JV initially trades non-yuan products, such as foreign currency forward trades but it also wants to move into yuan-based products.

Reuters, meanwhile, recently opened a financial risk research laboratory with Tsinghua University to train Chinese students in applying risk models and live derivatives trading.

China lives in interesting, if risky times.

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