FACTBOX-What is an iron ore swap contract?
Feb 12 (Reuters) - The popularity of iron ore swap contracts has been boosted by the breakdown of the decades-old annual benchmark system in iron ore contract pricing in 2010 and a switch to methods based on daily spot market prices.
The Singapore Exchange was the first to launch an iron ore contract in 2009 and currently clears more than 90 percent of market volumes, but other exchanges are strengthening their offerings to cash in on this fledgling market.
Among them is IntercontinentalExchange Inc, which on Monday launched two iron ore swap futures contracts.
The following are basic details about the growing iron swaps market.
WHAT IS AN IRON ORE SWAP?
An iron ore swap contract is a cash-settled derivative between a seller and a buyer of iron ore at a fixed price for a set time that provides price certainty for both parties.
They can be priced against any of the three iron ore reference indices published by information providers - Platts, The Steel Index (TSI) and Metal Bulletin Iron Ore Index - which all say the index prices are based on actual transactions.
There are no physical deliveries in the cash-settled swaps but the most commonly used indices are based on spot physical iron ore delivered in China.
These contracts allow price and period differentiation throughout the market because they are negotiated between specific buyers and sellers.
This provides price stability without the rigidity of the benchmark system, in which the world's three biggest miners, Vale, BHP Billiton and Rio Tinto, used to sit down with a handful of steel mills to agree on prices that were then applied across the market.
WHO IS INTERESTED?
Banks, but also iron ore miners and physical iron ore traders, are the major driver of the market, although increasingly interest is seen from the steel industry, particularly in Asia.
Market players say there is significant interest from small to mid-sized Asian steel mills.
A steel mill about to clinch a large steel contract - maybe with an automotive consumer wanting a fixed price for half a year - would appreciate the option to fix its input cost, which it can do through the paper iron ore market.
Also, an iron ore miner, wanting to fix its sale price for the next few months, can do so by using the paper market.
Liquidity in the paper market grew to more than 110 million tonnes in 2012, and brokers expect this to double in 2013, but it remains a challenge in this young market. The current paper volumes represent only about 10 percent of a physical seaborne iron ore market of about 1.1 billion tonnes.
The conservative steel industry is notorious for its opposition toward sophisticated hedging instruments in steel, which it says would distort prices due to the involvement of financial players. But analysts expect much swifter growth for these contracts, compared to steel futures, as some major iron ore producers such as BHP Billiton are promoting this market.
(Reporting by Humeyra Pamuk, Brian Ellsworth and Silvia Antonioli; Editing by Dale Hudson)