Published Date: 10 September 2009

Keynote Address by Mr Kola Luu, Executive Director, Financial Markets Strategy Department, Monetary Authority of Singapore, at the Commodity Derivatives Asia-Pacific, 10 September 2009, Raffles Convention Centre, Singapore


Distinguished guests,
Ladies and Gentlemen,
Good Morning.

With Asia's increasing influence on the global commodity market, it is my pleasure to join you here this morning to discuss the latest developments and issues in the commodity derivatives market. I understand this is the first time that FOW Events is organising the Commodity Derivatives Asia-Pacific event. I would like to take the opportunity to thank FOW Events for choosing Singapore as the location to host the inaugural Commodity Derivatives Asia-Pacific conference.

Global economic outlook

2   With unprecedented changes in the global financial landscape, the International Monetary Fund (IMF) had projected in April this year that the world economy will contract in 2009 for the first time since the Second World War [1]  .

3   However, a number of leading indicators have picked up recently and consumption spending has held up better than expected; the U.S. economy contracted by 1 percent in the second quarter this year [2], less than the decline projected by economists, and China's GDP growth was 7.9 percent in the same period [3]  , surpassing economists' expectations about the Chinese economic recovery. Improved market sentiments are also being reflected in the equity markets. Both the Dow Jones Industrial Average and the S&P 500 have rebounded, by more than 40 percent, after hitting 12-year lows in March this year.

4   In a recent article [4]  , IMF's Chief Economist Olivier Blanchard highlighted that "the recovery has started (but) sustaining it will require delicate rebalancing acts". This includes the rebalancing of aggregate demand across countries. This would require "a shift from domestic to foreign demand in the United States, and a reverse shift from foreign to domestic demand in the rest of the world, particularly in Asia."

5   Unprecedented deterioration in demand from developed economies took its toll on Asian exports and economic growth in the last quarter of 2008 and early this year. Although Asia's recovery from previous downturns had been led by rebounds in exports to developed economies, changing dynamics in the global market will likely provide the catalyst to alter this familiar growth recovery story of Asia. Instead, burgeoning domestic and regional consumption, due to the growing middle and upper classes in China, India and other Asian countries, will most likely contribute more significantly to Asia's sustained economic growth and pull Asia out of the global crisis.

Fundamental drivers of the commodity market remain strong and the Asian commodity market will continue to thrive

6   In the second half of 2008, the commodity market experienced a downturn against a backdrop of heightened uncertainties. Although the slowdown in global demand may have "derailed" the growth of the commodity market, it is widely believed that it would not put a permanent stop to the growth of this sector. The fundamental drivers of the global commodity market remain in place on a longer-term basis and Asia will continue to be a major engine of growth for the global commodity market.

7   Approximately two-thirds of the increase in global energy demand in the recent years was contributed by higher consumption and inventory build-up by Asian economies. According to this year's International Energy Outlook report released by the U.S. Energy Information Administration, non-OECD nations are expected to experience the most rapid growth in energy demand from 2006 to 2030. The average annual percentage change in Asia's energy consumption for the same period is estimated to be 3 percent, the highest among all regions[5]  .

8   Although some slowdown in Asia's growth has been observed and is expected to continue for sometime, rapid industrialisation and urbanisation in Asia will continue to spur demand for a wide range of commodities. For the past five years, consumer spending in emerging Asia increased by an average of 6.5 percent annually, much faster than that in other parts of the world [6]. Furthermore, falling commodity prices and expansionary monetary and fiscal policies undertaken by governments in Asia are boosting Asian consumers' purchasing power. Projected growth forecast for developing countries in Asia reflects a slowdown but will continue to grow at about 5.5 percent in 2009 [7] .  This is significantly higher than the projected contraction of 1.4 percent across the global economy in 2009 [8]. This is a reflection of Asia's resilience to the global financial crisis.

9   International trading firms recognise the opportunities in the Asian commodity market and continue to expand their operations in Asia. Singapore remains an attractive location for international trading companies who are looking to setup in Asia to ride on the regional wave of growth. To date, more than 270 international trading companies are based in Singapore, under International Enterprise Singapore's Global Trader Programme. These include some of the world's top integrated energy majors and the world's largest agri-commodity groups.

10   Similarly, many global financial institutions are also convinced of the growth and potential of Asia's commodity market. Players such as Morgan Stanley, Goldman Sachs, Barclays Capital, JP Morgan and Citigroup, just to name a few, which have their regional commodity operations based in Singapore, have been expanding their commodity business and teams in Asia even amidst the crisis.

Commodity derivatives as risk management and diversification tools

11   Although long term prospects for the commodity sector remain strong, supply of commodities could be disrupted in the short run due to various factors such as uncertainties in weather conditions, disease outbreaks and political events. The earliest innovations of commodity derivatives were created to help farmers reduce some of these uncertainties. In fact, the first recorded instance of futures trading dates back to the 17th century when rice futures were traded in Japan.

12   Uncertainties in commodity prices still exist today. We have experienced some of the most extreme movements in commodity prices in recent years. Prices of oil, metals, grains and other commodities had escalated sharply over a sustained period from 2002 to early 2008 [9]. However, in the second half of 2008, commodity prices fell significantly under the impact of the global crisis. WTI crude oil spot price surged to a record high of 145 US dollars per barrel in July 2008 but fell close to 30 US dollars per barrel within a span of six months, in December 2008. Similarly, global rice and wheat prices experienced extreme volatilities in 2008. Just last month, heavy rainfalls in Brazil and extreme drought in India pushed global sugar prices to 28-year highs [10]. In light of such unprecedented market volatilities, it is therefore even more important for commodity market players to manage their exposures through the commodity derivatives market.

13   Not only does the commodity derivatives market benefit participants of the physical commodity market, it also provides financial players with a wider range of instruments for portfolio diversification and hedging against inflation. Commodities tend to bear a low to negative correlation to traditional asset classes and are one of the few asset classes which offer protection from the effects of inflation. As such, investor interest in commodities has soared in recent years. Barclays Capital estimated that total assets under management in commodities reached 154 billion US dollars in the fourth quarter last year. This figure has further increased by approximately 36% to 209 billion US dollars in the second quarter this year[11].

Increased demand for OTC clearing to mitigate counterparty risk

14   The OTC commodity derivatives market experienced robust growth in recent years. Notional amounts of outstanding commodity OTC derivatives contracts reached record highs of 13 trillion US dollars in June 2008 [12]. On an aggregate level, the notional amounts of outstanding commodity OTC derivatives contracts more than doubled from 1.4 trillion US dollars as at end of 2003 to 4.4 trillion US dollars as at end of 2008[13].

15   The global financial crisis, along with extreme volatilities in commodity prices in the past year has heightened concerns over counterparty credit risk. This has resulted in a surge in interest to transfer bilateral OTC transactions to a cleared environment through the use of central counterparty clearing facilities. Average daily volume cleared on CME ClearPort was up by 39 percent in 2008[14]  and, similarly in Singapore, the volume of OTC trades cleared on SGX AsiaClear doubled in 2008[15].

Commodity exchanges as transparent platforms for hedging

16   While it is crucial to have efficient platforms to facilitate OTC commodity trading and clearing activities, commodity exchanges are also critical in providing players with transparent and efficient instruments to hedge their exposures. According to BIS Statistics, total global turnover in exchange-traded commodity derivatives increased by approximately 23% from approximately 1,400 million contracts in 2007 to 1,700 million contracts in 2008.

17   Although Asia is a major consumer and producer of several commodities, its influence on global commodity prices has been relatively muted. Many Asian commodity players continue to benchmark against commodity derivatives listed on U.S. and European exchanges such as energy futures on New York Mercantile Exchange (Nymex), agricultural futures on Chicago Board of Trade (CBOT) and metals futures on London Metals Exchange (LME). This phenomenon is largely attributed to the highly fragmented nature of the Asian commodity derivatives market which limits the effectiveness of price discovery and risk management.

18   Over the past decade, several commodity exchanges have emerged in Asia, particularly in China and India, to address the region's need for more price discovery and risk management instruments for the commodities market. Among which, Dalian Commodity Exchange, Zhengzhou Commodity Exchange, Shanghai Futures Exchange and the Multi Commodity Exchange of India are among the top 25 derivative exchanges worldwide[16]. Some of the world's most liquid commodity futures are traded on the commodity exchanges in Asia. It is notable that the white sugar futures on Zhengzhou Commodity Exchange and the soybeans futures on Dalian Commodity Exchange are the top two agricultural futures traded worldwide in 2008[17]. However, while there are several sizeable commodity exchanges in Asia, many of these exchanges are domestic in nature due to regulatory restrictions on foreign participation.

19   Besides enhancing the market infrastructure, there is a pertinent need for commodity exchanges to ensure that contract specifications cater to the needs of Asian commodity players. As the Asian commodity market develops further and becomes increasingly sophisticated, there is greater demand for ‘Asian solutions' for the pricing of Asian-centric commodities.

Singapore as a trusted Asian Hub for trading and risk management

20   To capitalize on the greater demand for 'Asian solutions', I note that the Singapore Commodity Exchange (SICOM), a wholly owned subsidiary of the Singapore Exchange (SGX), will be launching a coffee futures contract. With Vietnam and Indonesia being the world's two largest Robusta coffee producers, there are many coffee exporters and traders based in Asia. I am confident that a well-designed coffee futures contract will serve as an effective risk management instrument for various participants of the coffee industry based in Asia and Singapore. I also note that SICOM had announced its intention to launch the world's first exchange-traded Deferred Settlement Gold Contract yesterday at the Derivatives World Asia 2009.

21  SGX has similarly been active in the development of new commodity futures. It was announced earlier this year that SGX will be launching a fuel oil futures contract to offer a new instrument for players in the fuel oil industry to hedge their exposure through the derivatives market.

22   Another significant development in Singapore's commodity derivatives market is the setup of a new commodity derivatives exchange. As most of you would be aware, India's Financial Technologies Group has announced plans to establish the Singapore Mercantile Exchange (SMX). SMX, which targets to launch in the fourth quarter this year, will provide an electronic trading platform for trading of futures and options contracts across a diversified range of commodities.

23   On the regulatory front, extreme price volatilities have raised concerns about speculation in the commodity derivatives market. Although speculators may contribute to greater liquidity in the derivatives market, their activities may result in higher price volatilities. The U.S. and European regulators have expressed concerns about the impact of speculative forces on oil prices and are reviewing the need to tighten regulations to curb speculative activities in the commodity derivatives market.

24   In Singapore, the regulation of all futures related activities has been consolidated under the Monetary Authority of Singapore (MAS) since February 2008. We recognise that transparent legal and regulatory structures are important prerequisites for a sound commodity derivatives market. IE Singapore and MAS will continue to monitor the markets closely and maintain dialogue with other stakeholders in the commodities market to ensure that while Singapore's regulatory framework remains robust, it offers a conducive environment for the development of a successful commodity derivatives market.

25   In our continual efforts to strengthen Singapore’s position as Asia's leading commodity derivatives hub, we also recognise that there is need to further deepen the knowledge base. In 2007, the Singapore Management University (SMU), in collaboration with IE Singapore and players from the trading industry, launched the International Trading Institute (ITI) to further enhance sectoral knowledge, capabilities and talent pool in the arena of international trading. We also recognise the importance to provide greater opportunities for the commodity derivatives trading community to network and exchange insights at conferences of this nature.

26   In closing, I would like to highlight that while the long-term prospects of the Asian commodity market remains strong, we should not let our guard down. Asia would face challenges, such as resource management and environmental protection, while addressing its growing commodity needs. However, there is a Chinese saying, " 前事不忘, 后事之师 " – that is, "the past that should not be forgotten may serve as a guide for the future". Asia has learnt from its lessons and emerged more resilient from the 1997 Asian crisis. With relatively higher aggregate growth and larger aggregate size, I believe that Asia will be the locus of global commodity market growth.

27   On this note, I wish you all a successful conference and to our overseas speakers and delegates, a pleasant and fruitful stay in Singapore.

[1] World Economic Outlook, International Monetary Fund, April 2009
[2] U.S. Department of Commerce, Bureau of Economic Analysis, August 2009
[3] National Bureau of Statistics of China, July 2009
[4] Finance & Development: Sustaining a Global Recovery, Olivier Blanchard, September 2009 
[5] International Energy Outlook 2009, Energy Information Administration, U.S. Department of Energy, May 2009
[6] 'Consumer spending in Asia: Shopaholics wanted', The Economist, 25 Jun 2009
[7] World Economic Outlook Update, International Monetary Fund, July 2009
[8] World Economic Outlook Update, International Monetary Fund, July 2009
[9] Indices of Primary Commodity Prices, International Monetary Fund
[10] 'Sugar prices soar to 28-year high', Rabobank, 18 August 2009.
[11] Commodity Investment Flows - Q2 09 Update, Barclays Capital, 05 August 2009
[12] BIS Statistics
[13] BIS Statistics
[14] 'CME Group Volume Averaged 13.0 Million Contracts per Day in 2008, Up 4 Percent From 2007 on a Combined Basis', CME Group, 5 January 2009
[15] SGX AsiaClear
[16] FIA Annual Volume Survey, March 2009
[17] FIA Annual Volume Survey, March 2009