CME Group's Aluminum Swap Futures Contract: Will It Heat Up?

MetalMiner on CME aluminum swaps

The CME Group is confident that its aluminum swaps contract will see its first trades by the end of the year, if a Reuters interview with the CME’s managing director of metals products Harriet Hunnable is anything to go by.

While Hunnable asserts, to a degree, “if you build it, they will come,” skeptics say that “while the CME’s plan is credible, there is a lack of potential marketmakers to ensure the success of any premium-hedging instrument,” according to the report.

The report also points out that some customers also might hesitate when “double-paying” fees and margins — one to hedge the premium and another to hedge the LME base price.

For another perspective, I caught up with MetalMiner co-founder and contributing editor Stuart Burns.

Q: From a commodity risk management standpoint, will hedging with this new contract really solve the issue of buyers dealing with high premiums?

Stuart Burns: I really cannot say with any confidence if it will help with the premiums. On the face of it, I don’t see why it would — a swap doesn’t really get around the premium for obtaining metal in a particular physical location. The CME may argue otherwise, but I am yet to be convinced.

Q: How long will it take for the contract to build critical mass? In other words, are there enough “marketmakers,” as Reuters puts it, to make it worthwhile?

SB: Depends on your definition of ‘critical mass.’ Arguably, it has taken the Asian iron ore swaps market since 2009 to reach something like widespread acceptance by the trade — that’s some three years. It now realistically represents the spot market and has something approaching a significant percentage of the physical market volumes — maybe 15 percent — to be said to fairly reflect what’s going on. Most importantly, maybe producers, consumers and traders have [finally] started turning to the market to hedge risk; prior to this year that was limited.

Q: How can the LME aluminum warehousing crisis, which is making way for these new contracts, possibly be resolved?

SB: On the warehousing market, the only solution I can see — and take this with a pinch of salt — is for the LME to change its rules and force the warehouse operators to deliver more quickly from store. The high physical premiums and the restricted warehouse delivery rules are linked. I don’t see swaps changing that in the short term, so I think the LME has to get its house in order on this or it risks having its reputation as the price-setting market sullied by allowing the few to manipulate the many.

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