China's Baosteel Group, the country's second-largest steel maker, has urged Chinese mills to exercise caution in using iron ore swaps as a way to hedge against price volatility, citing credit risks as well as miners' ability to influence prices.
With most of iron ore swap contracts currently settled against the TSI index, Dai Zhihao, vice-president of Baosteel, said "miners were able to influence the indices by controlling the spot market".
"My view is that Chinese steelmakers should be cautious when trading iron ore swaps," Dai told an industry conference held in the northern city of Qingdao.
Dai said steel mills should also be wary of counterparty risks arising from swaps that are traded over-the-counter, because the participating members could default on their contracts.
The breakdown of the decades-old annual benchmark system in iron ore pricing last year has encouraged some Chinese firms to start trading in the nascent swaps market.
Dai's comments highlight deep concerns by steelmills that a growing acceptance of iron ore derivatives would further erode their price-setting power, as they continue to question whether the spot market truly reflects supply and demand fundamentals.
In a bid to wrest back some pricing power, China, the world's top iron ore consumer, plans to launch its own iron ore price index from October this year, which it hopes will also be used as the basis of quarterly contract prices set by Rio Tinto , BHP Billiton and Vale .
Dai also said China's iron ore production would see limited growth due to declining ore quality and rising labour costs.
However, he added that the current iron ore supply crunch could soon ease as more mines come onstream globally.
The CME group, Singapore Exchange, London Clearing House and the Indian Commodities Exchange all offer cleared swaps based on the Steel Index's (TSI) iron ore transaction data. The CME also offers a Platts-based swap in addition to the TSI swap clearing.