11/30/2012 — NEW YORK — Steel derivatives continue to face an uphill battle as concerns over illiquidity and price risk keep some would-be participants on the sidelines, but advocates of the nascent products maintain swaps and futures will find a place in the global steel sector yet.Once the realm of energy, agriculture and base metals, the futures markets have been expanded in recent years to encompass six steel products—including hot-rolled coil, rebar and billet—as well as a number of related raw materials, from iron ore to ferrous scrap.Although some steel derivatives have started to see traction—with the newest product, CME Group’s No. 1 busheling futures contract financially settled against AMM’s Midwest Scrap Index, trading more than 3,000 tons in its first full month in existence—others have been slow to gain acceptance in the marketplace.

“In the U.S., we have a lot of difficulty with our steel community. They generally are not inclined to be educated about the history of financial derivatives in this country. They read headlines, and the headlines talk about a rogue trader in London … and they figure they shouldn’t be involved in it,” Jeremy Flack, founder and president of Cleveland-based steel distributor Flack Steel Ltd., said during a steel swaps webinar hosted by London-based Freight Investor Services Ltd. (FIS). “We spend a lot of time here just getting people not to be afraid. There are a lot of misconceptions.”

According to Flack—whose company has been vocal in its belief that service centers should offer hedging services alongside cutting and slitting—said the misconceptions surrounding the use of steel derivatives largely stems from a belief that hedging introduces more risk into a company’s trading book.

“(One) misconception is if I lock in a price and the price goes down, I could lose. (But) if used correctly, you’re taking risk out of the equation,” he said. “You’re not going to get rid of volatility in hot-rolled coil. The price itself is not going to stop being volatile if you engage in using these instruments, (but) you’ll just take some price risk out of your own business. We think the small price for the vaccine is nothing compared to the benefit of being vaccinated.”

Phillip Price, structured products manager at Stemcor Risk Management AG, Zug, Switzerland, a unit of London-based trading house Stemcor Ltd., agreed that the use of futures offers a net benefit.

“If you have any possibility to build in the use on long-term contracts or even short-term contracts where pricing is linked to an index, it greatly enhances your ability to manage risk. It also gives you the ability to have much greater forward visibility of your business on a day-by-day basis,” he said.

But despite its proponents’ insistence, many physical market participants—particularly steel mills—continue to eye the fledgling products with caution.

Part of that concern is tied to liquidity concerns, FIS steel derivatives broker Sam Mehew said. “The steel industry is so much more fragmented than the iron ore market. We’ve got about six traded steel products out there at the moment, whereas iron ore has only one focus. So the nature of it is all the liquidity is spread a little bit thinly across all the six contracts. I’m afraid that’s the nature of the beast, really,” he said.Nonetheless, advocates maintain that the tide is turning.

“We’re starting to see liquidity come in on the contracts and they are building, but they are a nascent market and we’ve got to start somewhere. It’s growing, and we’re pleased to see the growth so far,” Mehew said.

Flack agreed, noting that as more regional banks and trading desks push to get their clients involved in hedging, the products are expected to really take off. “At some point, this market is going to take off like the oil market, like the aluminum market, and you don’t want to get left behind,” he said.