Iron awe: How Singapore became world's main trading hub in just 10 years

MOST cycling and barbecue enthusiasts in East Coast Park would have seen heavily laden vessels carrying a variety of commodities, mostly heading eastwards. Some of the largest of these ships are VLOCs (Very Large Ore Carriers) carrying iron ore to steelmakers in China, South Korea and Japan, after having stopped in Singapore to refuel. The city-state, however, is more than a gas station for these iron ore ships. In the last 10 years, it has become the world's main trading hub of the US$100 billion a year industry.

Digging back into iron ore's past, you do not have to go far to find secretive smoke-filled cigar rooms wherein senior executives would strike an annual price. While allowing both sides to have some visibility on prices for the year to come, this annual "benchmark" had one key weakness: it could not keep up with live, or spot, market prices, which move constantly depending on the demand-supply balance. This means that when a price moved sharply, it was not uncommon for one side to feel aggrieved, or even in many cases, refuse to pay for the cargo.

This decades-old system finally broke down between 2008 and 2010, when both sides struggled to find common ground as the global financial crisis and China's rapid urbanisation had imbalanced the physical iron ore market, leading to unprecedented volatility in prices, and eventually to a much needed modernisation of the industry.

A key driver for this transformation was the availability of better information, particularly pricing information. About 10 years ago, on June 2, 2008, commodity news and pricing agency S&P Global Platts launched the world's first daily iron ore price assessment, IODEX, from its Singapore office. Over the next two years, this price would gradually replace the old benchmark as more companies opted to price their physical iron ore using modern market-tracking techniques.

Iron ore derivatives

The other big catalyst for the change was the emergence of an iron ore futures market on the Singapore Exchange. SGX started clearing iron ore derivatives in April 2009 and over the years, the trading volume has exploded to the point where now more "paper" iron ore trade is taking place than physical.

These futures contracts are critical for modern, functional commodity markets as they allow producers, consumers and traders to manage their price risk by hedging - protecting them from the inherent volatility of most markets. SGX's success was, in great part, thanks to its strong affinity to its Asian, especially Chinese, customer base. Other global exchanges have tried to launch iron ore futures but have struggled to woo Chinese participants as well as SGX has.

The timing has also worked very well for Singapore, which had started attracting large mining companies in the first decade of the 21st century, starting with BHP Billiton and followed by Vale, Rio Tinto, Anglo American and Glencore, among others. In the ensuing years, large Chinese steelmakers set up their local trading arms, and a whole ecosystem of companies - including trading firms, brokerages and consultancies - came into existence to provide services to the metals and mining industries. These came on top of already established world-class banking and legal sectors. The benefits of being just a few streets away from all of your clients and suppliers were obvious. In contrast, if you wanted to connect with your European peers, you would need flights to Germany, the Netherlands, Switzerland, Luxembourg and the UK.

Furthermore, those ships off East Coast Park also carry a wide variety of other commodities, and Singapore is an established trading hub for a number of them. In particular, energy, both thermal and metallurgical coal, and steel have obvious adjacencies with iron ore, providing yet another reason for iron ore market participants to congregate here.

Position cemented

Cementing Singapore's position further is the Singapore Iron Ore Week, which has become the high point in the global iron ore calendar. The conference, organised by SGX every year in May, attracts hundreds of global executives - a remarkable feat for a garden city which does not produce or import a single ton of the material.

So how secure is Singapore's status as the capital of iron ore? Reasonably so for now, but there can be no complacency as challengers are emerging. As in many other areas, China has been increasingly assertive. Dalian Commodities Exchange launched iron ore futures in 2013 and saw trading volume soar, thanks to the sheer number of retail domestic investors taking part. Along with the rising physical iron ore trade volume, the number of transactions in Chinese ports has increased too. These transactions are for smaller parcels and are yuan-denominated. Perhaps that is why a number of iron ore miners and traders have recently boosted their presence in China, particularly in Shanghai.

But significant volumes on Chinese exchanges have not come at the expense of SGX's volumes. Quite the opposite - they have tended to grow in tandem. Additionally, Singapore's better connectivity to international markets, as well as increased activity in adjacent and downstream markets such as coking coal and steel, should all play a role in safeguarding the city-state's leadership position.

Given its uniquely strong correlation with Chinese industrial activity, some traders and investors predict iron ore will develop a greater appeal to international investors in the coming years, joining the ranks of oil, wheat and copper as a "global commodity". With the mix of attributes that Singapore has, it is hard to imagine a city better placed to help propel this magnetic red dirt to the next stage of its evolution.

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