August 2, 2018 / 3:13 AM / 3 months ago

Shanghai exchange mulls market makers to boost crude futures liquidity

BEIJING (Reuters) - Shanghai International Energy Exchange (INE) is considering appointing market makers to boost trading volumes in its nascent crude oil futures amid growing concerns about liquidity as the first contract heads for expiry later this month.

An oil tanker unloads crude oil at a crude oil terminal in Zhoushan, Zhejiang province, China July 4, 2018. Picture taken July 4, 2018. REUTERS/Stringer

Responding to a report by Reuters earlier on Thursday, the INE, part of the Shanghai Futures Exchange (ShFE), said in an email that it was studying introducing a market-maker scheme following requests from some investors.

The exchange has approached at least two major brokers in recent weeks about finding investors to help drum up business in the less-active forward months, two sources familiar with the matter said.

Those investors would be similar to market makers, who are often deployed by international exchanges such as CME Group Inc and Intercontinental Exchange to fuel activity in new contracts.

“In recent days, some market investors have asked the exchange to follow practices from other international exchanges and introduce the market making scheme to further provide liquidity for forward month contracts,” the INE said.

“We are seriously considering the request and demands from investors and are currently studying and seeking advice from investors for a plan,” the exchange said.

The potential candidates for the role would be institutional investors, such as wealth managers and hedge funds, the sources said. The sources declined to be identified as they are not authorised to speak to the media.

The move comes amid worries among investors and brokers that liquidity in the market is concentrated in the September contract, which expires at the end of this month.

September’s expiry is seen as a big test of China’s first yuan-denominated oil contract, which was launched four months ago aimed at gaining greater clout in global crude pricing.

“More investors will roll their September contracts into December in the coming weeks. Right now, liquidity in December is not high enough to attract big investors,” said Wang Xiao, head of crude oil research with Guotai Junan Futures.

State-controlled oil majors have helped provide liquidity, but getting a commitment from other investors to do so would enhance efforts to increase interest in the market.

(For a graphic on 'China's crude liquidity boost' click reut.rs/2KiPBug)

PLACES THIRD IN TURNOVER

Monthly exchange data shows that turnover in the contract has surged since its launch. In July, it accounted for 7 percent of global turnover in oil futures, taking third place behind London’s Brent and U.S. West Texas Intermediate (WTI), with Arab oil heavyweight Dubai in fourth.

But most of the daily turnover and open interest, a measure of liquidity, is concentrated in the September contract, which expires at the end of this month. The December contract has a cluster of activity, but the drop-off is steep.

Chinese commodity futures investors do not typically trade steadily over the months, but instead pick specific months in which they deal.

That complicates efforts to trade spreads between Brent, WTI and Shanghai.

“The monthly gap between Shanghai contracts and global oil futures created difficulties for arbitrage,” said Wang.

Having more liquidity spread out across forward months is considered important for luring international hedge funds and other financial players, who like to trade month by month.

Open interest across the first five months of the Brent and WTI contracts <0#LCO:> and <0#CL:> is relatively evenly spread out.

INE slashed fees for the October and November contracts last month and on Tuesday cut them for the January and February months, which was seen as an effort to make liquidity spread out more evenly across forward months and to engage in industrial traders such as refiners who tend to trade month by month, the INE said.

Combined open interest in those four contracts was just 445 lots on Thursday, equivalent to just under 500,000 barrels of oil and tiny in comparison to September which has almost 14,000 lots of open interest.

(For a graphic on 'Shanghai crude's rise' click reut.rs/2n39gFu)

Reporting by Meng Meng and Josephine Mason; Editing by Eric Meijer and Tom Hogue

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