Following the Chinese government’s plan to internationalize its commodity futures markets, the PTA and iron ore futures contracts, traded on the Zhengzhou and Dalian commodity exchanges respectively, have become accessible to foreign investors in 2018. This is the first study to investigate how market quality, trading activity and volatility react to this milestone event. Based on an extensive set of ultra-high frequency data, we analyzed the impact of internationalization on bid-ask spreads, price impact, volume, trade size and realized volatility.
Starting with a univariate analysis, the impact of market liberalization was then assessed through a difference-in-difference approach, followed by possible explanations and various robustness checks.
We found conclusive evidence suggesting that internationalization has led to an improvement in the market quality of PTA futures. Post-internationalization, the trading volume and number of trades increased while the trading cost was largely unaffected. The observed positive effects on PTA futures are in line with the existing literature, documenting that a stronger presence of foreign investors improves the liquidity of local markets. In contrast, iron ore futures exhibit a puzzling pattern at the first glance. Trading volume and number of trades have decreased, while the trading cost increased. The documented decrease in market
am Chinese local time (Fung et al., 2016). For simplicity, we apply the same classification across all commodities which have night-time trading.
31
activity is associated with a reduced revenue for liquidity providers and an increased adverse selection. Whilst the pronounced deterioration is unlikely to be caused by the activities of new hedgers and speculators entering the market, an analysis of the mispricing between the SGX and DCE iron ore reveals a plausible explanation. Backed up by the documented significant decline of large trades in the Chinese iron ore market, large arbitrageurs have ceased their trading activities due to the profitability erosion following the entrance of foreign arbitrageurs post-internationalization.
Our findings shed lights on the ongoing market liberalization in China. The evidence on PTA supports China’s decision to accelerate the internationalization of unopened markets.
It also offers fresh insights for other emerging markets, not yet open to foreigners (e.g. India).
The increasing participation by foreign institutions are expected to further improve the market quality. Recent experience from the Tokyo Commodity Exchange reveals that the foreign volume has grown from 9.7% to 44.5% in 2008-2014 (METI, 2015). However, lessons from the iron ore markets suggest a more thorough investigation of the domestic dynamics may be warranted, prior to the introduction of foreign investors. For example, as one of the world’s most liquid futures, the iron ore market once had the largest depth among the black metals in China, while the non-individuals accounted for less than 3% of the total accounts. Although large arbitrageurs exited the market due to the erosion of arbitrage profits post- internationalization, it might be worthwhile to consider why these orders were initiated at the first place. A closer investigation into large orders by non-individuals may shed further light on the deterioration of market quality. Finally, we recommend the regulators to improve the transparency of traders’ positions data by business purposes and classifications.
32 References
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36
Appendix A. Iron ore futures contracts
Exchange NYMEX1 DCE2 SGX3
Contract Unit 500 MT/Lot 100 MT/Lot 100 MT/Lot
Price Quotation USD/MT RMB/MT USD/MT
Trading Hours Sunday - Friday 6:00 p.m. - 5:00 p.m.
60-minute break at 5 p.m.
Monday - Friday 9:00 - 11:30 a.m.
1:30 - 3:00 p.m.
9:00 - 11:00 p.m.
Daily
7:25 a.m.- 7:55 p.m.
8:15 p.m.- 4:45 a.m.
Min Price Fluctuation $0.01 / MT 0.5 CNY/MT $0.01 / MT
Price Limit Levels 1-4: 1,200; 2,400;
3,600; 4,800 Levels 1-3:
4%; 7%; 9% None
Position Limit Spot Month: 15,000 Spot Month: 2,000 None
Margin Tier 1-4: 2,795; 4,100;
3,700; 3,200 Tier 1-4: 16,330; 7,290;
6,555; 6,035; 5795 Tier 1-5: 1,100;|1,078;
924; 902; 792
Settlement Method Cash Physical Cash
Maturity Month All All All
1 https://www.cmegroup.com/trading/metals/ferrous/iron-ore-62pct-fe-cfr-china-tsi-swap-futures_contract_specifications.html
2 http://www.dce.com.cn/DCE/Products/Industrial/Iron%20Ore/491886/index.html
3 https://www2.sgx.com/derivatives/products/iron-ore?cc=FEF#Contract%20Specifications
37
Appendix B. Chinese commodity futures list
Commodity Symbol Exchange
Panel A: Black Metals
Iron ore DCIO Dalian Commodity Exchange (DCE) Ferrosilicon CESF Zhengzhou Commodity Exchange (ZCE) Silicon manganese CESM Zhengzhou Commodity Exchange (ZCE) Thermal coal CZC Zhengzhou Commodity Exchange(ZCE)
Coke DCJ Dalian Commodity Exchange (DCE)
Coking coal DJM Dalian Commodity Exchange (DCE) Steel rebar SRB Shanghai Futures Exchange (SHFE) Panel B: Plastics & Industrials:
PTA CTA Zhengzhou Commodity Exchange (ZCE)
Flat glass CFG Zhengzhou Commodity Exchange (ZCE)
PP DCC Dalian Commodity Exchange (DCE)
LLDPE DLL Dalian Commodity Exchange (DCE)
PVC DPV Dalian Commodity Exchange (DCE)
Crude oil ISC Shanghai International Energy Exchange (INE) Natural rubber SNR Shanghai Futures Exchange (SHFE)
38
Appendix C. Robustness: Shorter event window
This table reports the results from the difference-in-difference approach for Iron ore (Panel A) and PTA (Panel B). We consider 6-month before and 6-month after the internalization event which is May 4, 2018 for iron ore and November 30, 2018 for PTA. We skip the first month after the event. The pre-event periods are from November 1, 2017 to May 3, 2018 (from May 31, 2018 to November 29, 2018) for iron ore (PTA). The post-event period is from June 1, 2018 to November 31, 2018 (from January 1, 2019 to June 28, 2019) for iron ore (PTA). The first row shows the various market quality as dependent variables: Volume (total daily volume), Trade (total daily number of trades), Small (the percentage of trade with less than 5 contracts), Medium (the percentage of trade with contracts between 5 and 50), Large (the percentage of trade with more than 50 contracts), QS (quoted spread), ES (effective spread), RS (realized spread), PI (price impact), and RV (the daily realized volatility). Volume, trade, bid/ask depth and RV are in logs. IO (PTA) is an indicator variable which equals to 1 for iron ore (PTA) and 0 otherwise. Post is an indicator variable which equals to 1 after June 1, 2018 (January 1, 2019) for iron ore (PTA) and 0 otherwise. Controls includes the log changes in RMB/USD and the difference in 10-Year Bonds between China and US. We employ commodity fixed effects. Figures in parentheses are t-statistics robust to heteroscedasticity and clustered by commodity. ***, ** and * denote statistical significance at the 1%, 5% and 10% level, respectively.
Volume Trade Small Medium Large Bid depth Ask depth QS ES RS PI RV
Panel A: Iron Ore
Post -0.39 -0.09 0.34 -0.15 -0.27 0.01 -0.39 -0.88*** -0.77*** 0.23 -0.43** -0.26 (-0.84) (-0.27) (1.00) (-0.45) (-0.57) (0.02) (-0.94) (-4.16) (-3.69) (0.96) (-2.38) (-0.95) IO * Post -1.78*** -1.86*** 1.45*** -1.53*** -1.62*** 0.14 0.38 0.63*** 0.91*** -0.26* 0.48*** -0.97***
(-4.52) (-7.24) (4.70) (-3.99) (-4.81) (0.53) (1.41) (3.61) (4.70) (-1.88) (5.22) (-5.48)
Controls YES YES YES YES YES YES YES YES YES YES YES YES
Month FE NO NO NO NO NO NO NO NO NO NO NO NO
Commodity FE YES YES YES YES YES YES YES YES YES YES YES YES
Adj-R² 9.3% 16.1% 7.6% 3.0% 8.2% 5.8% 8.2% 41.4% 24.2% -2.0% 3.1% 8.0%
Obs. 280 280 280 280 280 280 280 280 280 280 280 280
Panel B: PTA
Post -0.21 -0.25 1.47*** -1.66*** -0.68 2.38*** 1.91*** -1.83** -1.88*** 0.79** -1.29*** -1.69***
(-0.91) (-0.50) (6.40) (-7.36) (-1.36) (5.01) (6.42) (-2.31) (-4.48) (1.98) (-3.97) (-4.89) PTA * Post 1.85*** 1.53*** -1.92*** 0.47** 1.88*** 0.54*** 0.58*** -0.04 -0.80** 0.19 -0.55*** -0.12 (6.16) (4.99) (-8.34) (2.42) (4.85) (4.66) (4.34) (-0.09) (-2.19) (1.10) (-3.18) (-0.86)
Controls YES YES YES YES YES YES YES YES YES YES YES YES
Month FE NO NO NO NO NO NO NO NO NO NO NO NO
Commodity FE YES YES YES YES YES YES YES YES YES YES YES YES
Adj-R² 6.2% 2.0% 8.1% -0.1% 6.6% 51.4% 47.5% 3.3% 8.5% 1.0% 5.5% 20.1%
Obs. 308 308 308 308 308 308 308 308 308 308 308 308
39
Appendix D. Robustness: Skipping one month before event
This table reports the results from the difference-in-difference approach for Iron ore (Panel A) and PTA (Panel B). We consider 6-month before and 6-month after the internalization event which is May 4, 2018 for iron ore and November 30, 2018 for PTA. We skip the first month after the event. The pre-event periods are from November 1, 2017 to May 3, 2018 (from May 31, 2018 to November 29, 2018) for iron ore (PTA). The post-event period is from June 1, 2018 to November 31, 2018 (from January 1, 2019 to June 28, 2019) for iron ore (PTA). The first row shows the various market quality as dependent variables: Volume (total daily volume), Trade (total daily number of trades), Small (the percentage of trade with less than 5 contracts), Medium (the percentage of trade with contracts between 5 and 50), Large (the percentage of trade with more than 50 contracts), QS (quoted spread), ES (effective spread), RS (realized spread), PI (price impact), and RV (the daily realized volatility). Volume, trade, bid/ask depth and RV are in logs. IO (PTA) is an indicator variable which equals to 1 for iron ore (PTA) and 0 otherwise. Post is an indicator variable which equals to 1 after June 1, 2018 (January 1, 2019) for iron ore (PTA) and 0 otherwise. Controls includes the log changes in RMB/USD and the difference in 10-Year Bonds between China and US. We employ both month and commodity fixed effects. Figures in parentheses are t- statistics robust to heteroscedasticity and clustered by commodity. ***, ** and * denote statistical significance at the 1%, 5% and 10% level, respectively.
Volume Trade Small Medium Large Bid depth Ask depth QS ES RS PI RV
Panel A: Iron Ore
Post 0.14 0.51 0.52 -0.40 -0.50 1.06 1.07 -4.08*** -3.85*** 0.42 -1.92*** -2.55***
(0.28) (1.02) (1.04) (-0.69) (-1.08) (1.55) (1.29) (-11.96) (-8.27) (1.31) (-12.58) (-5.75) IO*Post -1.60*** -1.64*** 1.48*** -1.47*** -1.44*** -0.35 -0.32 0.75*** 1.17*** -0.25*** 0.81*** -0.60***
(-5.34) (-6.52) (4.93) (-5.93) (-4.34) (-1.07) (-0.95) (2.80) (5.33) (-4.29) (7.24) (-5.35)
Controls YES YES YES YES YES YES YES YES YES YES YES YES
Month FE YES YES YES YES YES YES YES YES YES YES YES YES
Commodity FE YES YES YES YES YES YES YES YES YES YES YES YES
Adj-R² 16.4% 17.8% 20.0% 15.9% 12.8% 28.5% 29.7% 34.0% 33.3% 3.3% 9.1% 34.9%
Obs. 1700 1700 1700 1700 1700 1700 1700 1700 1700 1700 1700 1700
Panel B: PTA
Post 1.10*** 0.93** -0.79*** 0.48** 0.92*** 0.60* 0.60* 0.40 0.14 -0.23 0.28 0.23 (3.04) (2.38) (-3.18) (2.20) (3.06) (1.74) (1.78) (0.97) (0.31) (-1.23) (1.07) (0.96) PTA*Post 0.80*** 0.76*** -0.57*** 0.52*** 0.46* 0.23 0.29 -0.22 0.04 0.00 0.02 0.70***
(2.82) (2.51) (-3.12) (5.62) (1.69) (0.98) (1.38) (-0.66) (0.12) (-0.01) (0.08) (3.49)
Controls YES YES YES YES YES YES YES YES YES YES YES YES
Month FE YES YES YES YES YES YES YES YES YES YES YES YES
Commodity FE YES YES YES YES YES YES YES YES YES YES YES YES
Adj-R² 24.4% 21.7% 15.3% 10.8% 14.9% 37.3% 35.5% 17.9% 8.1% 1.7% 1.4% 19.2%
Obs. 1681 1681 1681 1681 1681 1681 1681 1681 1681 1681 1681 1681
40
Appendix E. Robustness: Day-trading session
This table reports the results from the difference-in-difference approach for Iron ore (Panel A) and PTA (Panel B) for the day-trading session only.
We consider 6-month before and 6-month after the internalization event which is May 4, 2018 for iron ore and November 30, 2018 for PTA. We skip the first month after the event. The pre-event periods are from November 1, 2017 to May 3, 2018 (from May 31, 2018 to November 29, 2018) for iron ore (PTA). The post-event period is from June 1, 2018 to November 31, 2018 (from January 1, 2019 to June 28, 2019) for iron ore (PTA).
The first row shows the various market quality as dependent variables: Volume (total daily volume), Trade (total daily number of trades), Small (the percentage of trade with less than 5 contracts), Medium (the percentage of trade with contracts between 5 and 50), Large (the percentage of trade with more than 50 contracts), QS (quoted spread), ES (effective spread), RS (realized spread), PI (price impact), and RV (the daily realized volatility). Volume, trade, bid/ask depth and RV are in logs. IO (PTA) is an indicator variable which equals to 1 for iron ore (PTA) and 0 otherwise.
Post is an indicator variable which equals to 1 after June 1, 2018 (January 1, 2019) for iron ore (PTA) and 0 otherwise. Controls includes the log changes in RMB/USD and the difference in 10-Year Bonds between China and US. We employ both Month and commodity fixed effects. Figures in parentheses are t-statistics robust to heteroscedasticity and clustered by commodity. ***, ** and * denote statistical significance at the 1%, 5%
and 10% level, respectively.
Volume Trade Small Medium Large Bid depth Ask depth QS ES RS PI RV
Panel A: Iron Ore
Post 1.13* 1.41** -0.86 0.57 0.82 1.01* 0.13 -1.57** -1.90*** 0.50 -1.16*** -0.59**
(1.68) (2.34) (-1.44) (0.88) (1.45) (1.91) (0.21) (-2.24) (-3.95) (1.36) (-4.31) (-2.35) IO*Post -1.60*** -1.82*** 1.48*** -1.50*** -1.40*** -0.32 -0.28 0.78*** 1.04*** -0.33*** 0.75*** -0.73***
(-5.88) (-7.48) (5.33) (-6.12) (-4.71) (-1.12) (-0.97) (3.07) (5.08) (-5.55) (9.05) (-6.36)
Controls YES YES YES YES YES YES YES YES YES YES YES YES
Month FE YES YES YES YES YES YES YES YES YES YES YES YES
Commodity FE YES YES YES YES YES YES YES YES YES YES YES YES
Adj-R² 14.5% 19.4% 17.4% 13.9% 11.1% 26.4% 27.6% 33.5% 25.1% 2.3% 5.0% 25.5%
Obs. 1721 1721 1721 1721 1721 1721 1721 1721 1721 1721 1721 1721
Panel B: PTA
Post 0.47 0.00 -0.87** 0.65*** 0.91** 0.33 0.44 1.03 0.41 -0.42 0.54* 0.41
(1.00) (0.00) (-2.33) (2.51) (2.11) (0.86) (1.27) (2.41) (1.07) (-1.58) (1.67) (0.96) PTA*Post 1.02*** 1.06*** -0.57*** 0.42*** 0.46** 0.38* 0.43** 0.04 0.19 0.01 0.03 0.59***
(4.34) (4.02) (-3.66) (4.39) (1.97) (1.88) (2.30) (0.11) (0.54) (0.07) (0.18) (3.31)
Controls YES YES YES YES YES YES YES YES YES YES YES YES
Month FE YES YES YES YES YES YES YES YES YES YES YES YES
Commodity FE YES YES YES YES YES YES YES YES YES YES YES YES
Adj-R² 18.0% 18.3% 12.3% 10.0% 11.8% 41.8% 40.4% 23.4% 12.9% 2.1% 3.9% 22.6%
Obs. 1681 1681 1681 1681 1681 1681 1681 1680 1681 1681 1681 1681
41
Appendix F. Robustness: Night-trading session
This table reports the results from the difference-in-difference approach for Iron ore (Panel A) and PTA (Panel B) for the night-trading session only. We consider 6-month before and 6-month after the internalization event which is May 4, 2018 for iron ore and November 30, 2018 for PTA.
We skip the first month after the event. The pre-event periods are from November 1, 2017 to May 3, 2018 (from May 31, 2018 to November 29, 2018) for iron ore (PTA). The post-event period is from June 1, 2018 to November 31, 2018 (from January 1, 2019 to June 28, 2019) for iron ore (PTA). The first row shows the various market quality as dependent variables: Volume (total daily volume), Trade (total daily number of trades), Small (the percentage of trade with less than 5 contracts), Medium (the percentage of trade with contracts between 5 and 50), Large (the percentage of trade with more than 50 contracts), QS (quoted spread), ES (effective spread), RS (realized spread), PI (price impact), and RV (the daily realized volatility). Volume, trade, bid/ask depth and RV are in logs. IO (PTA) is an indicator variable which equals to 1 for iron ore (PTA) and 0 otherwise.
Post is an indicator variable which equals to 1 after June 1, 2018 (January 1, 2019) for iron ore (PTA) and 0 otherwise. Controls includes the log changes in RMB/USD and the difference in 10-Year Bonds between China and US. We employ both Month and commodity fixed effects. Figures in parentheses are t-statistics robust to heteroscedasticity and clustered by commodity. ***, ** and * denote statistical significance at the 1%, 5%
and 10% level, respectively.
Volume Trade Small Medium Large Bid depth Ask depth QS ES RS PI RV
Panel A: Iron Ore
Post -0.09 0.12 0.12 -0.01 -0.07 0.32* 0.68* -2.40*** -2.98*** 1.39*** -2.29*** -1.42***
(-0.20) (0.29) (0.22) (-0.03) (-0.13) (1.78) (1.75) (-5.61) (-10.49) (4.65) (-7.34) (-6.43) IO*Post -1.58*** -1.70*** 1.45*** -1.42*** -1.48*** -0.97*** -0.94*** 0.88*** 1.08*** 0.05 0.38** -0.61***
(-4.78) (-5.44) (4.34) (-4.27) (-4.95) (-4.39) (-4.19) (2.77) (4.06) (0.58) (2.21) (-3.00)
Controls YES YES YES YES YES YES YES YES YES YES YES YES
Month FE YES YES YES YES YES YES YES YES YES YES YES YES
Commodity FE YES YES YES YES YES YES YES YES YES YES YES YES
Adj-R² 18.8% 23.1% 23.2% 15.1% 16.3% 43.4% 43.7% 43.3% 32.0% 2.6% 6.0% 31.1%
Obs. 1195 1195 1195 1195 1195 1195 1195 1195 1195 1195 1195 1195
Panel B: PTA
Post 0.53* 0.30 -0.88*** 0.81** 0.84*** -0.42 -0.41 0.89** 0.64* -0.17 0.32 0.77**
(1.75) (0.78) (-2.77) (2.09) (2.77) (-0.88) (-0.82) (1.96) (1.94) (-0.55) (0.97) (2.00) PTA*Post 0.97*** 0.93*** -0.48*** 0.17 0.39** 0.85*** 0.87*** 0.22 -0.12 0.05 -0.14 -0.01 (13.57) (12.63) (-4.98) (1.55) (2.06) (4.18) (4.67) (0.52) (-0.33) (0.33) (-0.92) (-0.13)
Controls YES YES YES YES YES YES YES YES YES YES YES YES
Month FE YES YES YES YES YES YES YES YES YES YES YES YES
Commodity FE YES YES YES YES YES YES YES YES YES YES YES YES
Adj-R² 20.3% 21.3% 15.3% 10.9% 13.5% 29.2% 28.5% 24.0% 16.1% -0.2% 2.1% 16.5%
Obs. 1099 1099 1099 1099 1099 1099 1099 1099 1099 1099 1099 1098
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Table 1. Univariate analysis of the impact of internationalization
This table reports the differences in trading for iron ore (Panel A) and PTA futures (Panel B) before and after internalization. We consider 6-month before and 6-month after the internalization event which is May 4, 2018 for iron ore and November 30, 2018 for PTA. We skip the first month after the event. The pre-event periods are from November 1, 2017 to May 3, 2018 (from May 31, 2018 to November 29, 2018) for iron ore (PTA). The post-event period is from June 1, 2018 to November 31, 2018 (from January 1, 2019 to June 28, 2019) for iron ore (PTA). Volume is the average daily trading volume, Trade is the average total number of trades, Small represents the proportion of trades with less than 5 contracts, Medium for trades between 5 and 50 contracts, and Large for trades with 50 contracts and above. QS is the average daily percentage quoted spread, ES is the average daily percentage effective spread, RS is the average daily realized spread, PI is the average daily price impact, and RV is the daily realized volatility constructed using returns at 1-minute frequency. *** denotes statistical significance at the 1% level.
Before After Mean
Difference t-stat Median
Difference Wilcoxon test p-value
Panel A: Iron Ore
Volume ('000) 2369.49 1104.94 -1264.54*** (-9.91) -1190.26*** {0.00}
Trade ('000) 30.72 19.64 -11.08*** (-12.71) -11.41*** {0.00}
Small (n < 5) 34.4% 47.5% 13.0%*** (11.53) 12.7%*** {0.00}
Medium (5 ≤ n < 50) 46.7% 40.0% -6.7%*** (-12.43) -6.9%*** {0.00}
Large (n ≥ 50) 18.9% 12.6% -6.3%*** (-9.51) -5.9%*** {0.00}
Bid depth 1495.16 1483.98 -11.18 (-0.10) -102.10 {0.34}
Ask depth 1516.21 1534.66 18.46 (0.15) -105.64 {0.48}
QS 0.101% 0.102% 0.001% (0.71) 0.003%** {0.03}
ES 0.109% 0.113% 0.004%* (1.88) 0.007%*** {0.00}
RS 0.025% 0.022% -0.003%* (-1.80) -0.003%** {0.03}
PI 0.084% 0.091% 0.007%*** (3.10) 0.005%*** {0.00}
RV 0.0012 0.0010 -0.0003*** (-5.19) -0.0003*** {0.00}
Panel B: PTA
Volume ('000) 1290.01 2159.76 869.76*** (3.95) 1146.58*** {0.00}
Trade ('000) 26.48 32.12 5.64*** (3.09) 6.39*** {0.00}
Small (n < 5) 36.8% 29.5% -7%*** (-3.09) -8.1%*** {0.00}
Medium (5 ≤ n < 50) 44.5% 46.1% 2% (1.62) 0.2% {0.46}
Large (n ≥ 50) 18.6% 24.4% 6%*** (3.45) 7.7%*** {0.00}
Bid depth 183.99 312.85 128.86*** (7.51) 173.58*** {0.00}
Ask depth 181.98 311.15 129.17*** (7.99) 161.47*** {0.00}
QS 0.032% 0.034% 0.002%** (2.03) 0.001%*** {0.00}
ES 0.038% 0.038% 0.001% (0.81) 0.001% {0.24}
RS 0.008% 0.009% 0.001% (1.12) 0.000% {0.48}
PI 0.029% 0.029% -0.000% (-0.19) -0.001% {0.96}
RV 0.0009 0.0008 -0.0000 (-0.47) -0.0000 {0.96}