Trade war killed effort to create seafood futures market in China, expert says
One lesser-known impact of the trade war between the United States and China is the abrupt end to reform of China’s seafood and soy trading system, which had been underway as part of a package that would also address the country’s underperforming commodities exchanges.
In the past decade, there has been discussion in China in favor of dismantling the system of state supports for the grain and oilseed sector so that prices come into line with the international market. There was also talk of a fish futures contract in Dalian and even much reported rumors of a Chinese takeover of the Chicago Stock Exchange as part of greater Chinese participation in international commodity price-setting institutions. However, all of those moves appear to be parked for now as China uses soy purchases as a weapon in its trade dispute with the U.S.
Tristan Kenderdine, a former lecturer in public administration at Dalian Maritime University and current research director at Future Risk, a private research and advisory firm, has for many years studied China’s agricultural pricing system. In an interview with SeafoodSource, Kenderdine gave a primer on what has – and hasn’t – happened in the country’s agricultural reform movement, and offered insight into how reform to China’s agricultural pricing system remains bound up in long-festering policy problems in the country’s rural economy.
SeafoodSource: Previously, you suggested that the Dalian exchange was in talks with a major state-owned producer to establish a standardized contract for a seafood commodity contract – but this hasn’t yet happened. Is it likely to?
Kenderdine: There was some speculation of a seafood-based futures contract in 2017 as futures on hogs and apples were being prepared in the Dalian Commodity Exchange (DCE) and the Zhengzhou Commodity Exchange (ZCE), respectively. DCE dismissed speculation of a fish futures contract as rumor in 2017 and it seems to have fallen off the policy agenda.
SeafoodSource: You have suggested that major tilapia producers in China would flock to a legitimate price signal where production is still a cottage industry. What are the features of tilapia – compared to shrimp, carp, or pangasius – that make you believe this?
Kenderdine: My understanding was that tilapia was the most widely-farmed fish that was the most easily convertible to a fungible commodity. Previous attempts at seafood futures contracts have been on shrimp and salmon fillets. Naturally, the precursor to establishing a futures contract is having a uniform commodity to trade on. That means standardizing a fish fillet to be as similar to [one] other as possible. For that, you need consolidation of a few big producers to standardize a product. My understanding is that tilapia fits that bill because it is both so widely farmed and more easily standardizable than other fish species alternatives.
SeafoodSource: What are the main limitations of the Dalian and Zhengzhou commodity exchanges in comparison to their counterpart in Chicago?
Kenderdine: Liquidity. The failings of the Chinese futures exchanges is simply that there is not enough liquidity to adequately discover prices. There is either barely any trade, or a huge influx of speculators, like in the metals markets in 2016.
SeafoodSource: You have explained in academic papers how the market for two decades ignored the prices set by China’s exchanges. Can you summarize your findings?
Kenderdine: An interesting institutional factor is actually in [Communist] Party politics. The exchanges were set up during a period of [economic] opening under Party General Secretary Zhao Ziyang. Zhao was taken down following the  June Fourth movement and many of the projects that had his touch suffered under the “authoritarian modern” re-strengthening of party control that followed. The commodity exchanges were institutional casualties of this elite leadership change.
Once the exchanges had been institutionally marginalized, then they just languished. A lot of things need to go right for a market to start taking price signals from a futures exchange. But in China in the 1990’s and 2000’s, the exchanges were effectively divorced from agricultural production. And, naturally, after 2007 an agricultural price maintenance system was introduced with direct purchases of major grains and oilseeds. Who needs a futures contract or a price signal if the government is buying and stockpiling at a set price?
SeafoodSource: Can you explain why there was a rush of money into China’s commodities exchanges in 2016?
Kenderdine: The conventional answer is correct here. At that time, there was nowhere else for domestic speculative capital to flow, so it started betting on metals contracts. There had been a government orchestrated pump-and-prime policy for the equities markets on the stock exchanges from summer 2014. This was by and large successful as the herd mentality followed the expected gains from a cumulative causation effect and shares prices rose over the following 12 months.
The Shanghai Composite Index rose from around 2,200 in late 2014 to over 5,000 by June 2015. Then it crashed [to] back below 3,000 by August 2016. The government again stepped in, this time to try to stem the losses rather than to stoke investment. So by 2016, you have a saturated housing market, a dead duck equities market, a bond market that is the joke of the world, and an interest rate on savings below inflation. With the famous capital account limits in China, that meant the mattress or the futures markets. And because no one had really taken the futures exchanges seriously for decades, they were more loosely regulated than the equities markets. It’s easier to think of it as simply speculative capital chasing speculative capital rather than any meaningful investment. The hot money flowing into the futures exchanges were chasing quick profits off short-term risk when there were few other options to consume risk.
More interesting in the longer term was that, at the same time, there was a concerted effort by elements within the Chinese economy to participate more aggressively in international metals commodities markets like the London Metals Exchange and Chicago Metals Exchange. This was the same time that the talk started of a Chinese takeover of the Chicago Stock Exchange. I read the combination of more Chinese participation in international commodity price-setting institutions, the takeover bids for whole foreign institutions, and the institutional development of new futures contracts on the DCE and ZCE as China trying to import institutions. There had already been movement in the agricultural policy sectors to move to more market-driven institutions, and the balancing act in the equities and bond markets meant that building up a third major exchange-traded market would need some institutional finesse; They wanted to develop the exchanges into real markets, but they had a range of policy problems associated with doing so.
SeafoodSource: The 2016 No.1 Document (and subsequent issues of this document) have called for the reform of China’s agricultural futures and price-setting ability. How feasible of a target is this?
Kenderdine: Much less so since the start of the [Sino-U.S.] trade war – most of the policy momentum behind these reforms is gone. It was a real shame because it seemed to me that China was serious about this reform and was on the edge of introducing market price-setting mechanisms to agricultural production. They had gotten themselves into all kinds of trouble with the minimum-purchase price policy and there was a policy consensus to let markets do their job on this one. That could have been a huge boon for the global agricultural commodities markets, because the natural outcomes of market prices on agricultural commodities would be greater imports. And if China truly opened its grain and oilseed markets to global competition while reforming its own production, then we could have been in a world where everyone benefited. Unfortunately, with soy trade being weaponized against the United States, the international price-setting aspect of floating grain and oilseed prices has basically evaporated. This whole “fuures plus insurance” policy might be remembered much like Zhao Ziyang in the end.
SeafoodSource: You noted that such a reform would have to be in parallel with the development of agricultural finance and insurance reform. How likely is this given huge issues around land ownership?
Kenderdine: A huge undertaking and one that does not really work if international markets do not take the pressure off agricultural production. Solving rural affairs in China has been the single-biggest policy issue for 100 years. And they are not going to solve it in this decade. Before the trade war there was some hope, but now I am very skeptical of any meaningful reform in this policy cycle.
SeafoodSource: China in 2015 signaled it wanted to decouple agricultural subsidies from prices. What was the driver behind that decision?
Kenderdine: The decision was taken due to the ridiculous spread between international and domestic prices in grains and oilseeds. Minimum purchase prices were introduced when international prices were high and domestic prices were low, to support domestic farmers and to protect China from relying on expensive imports. But as is the nature of markets, the prices swung back the other way, and by 2014, the prices of all grains and oilseeds protected under the minimum purchase prices system were much cheaper on international markets – in some cases to the point of imports being 50 percent cheaper. So, China being China, the farmers kept producing for the farm-gate procurement price, the government stockpiled the grain and the processors – the link in the industrial chain that actually turns the grain into food product – were using grey-market import channels to buy cheaper international inputs. So the whole system was broken.
SeafoodSource: How developed are the futures markets and instruments in Asia as a whole?
Kenderdine: I have a limited knowledge here and, as with most commodities, much trade is still done structurally on point-to-point contracts. Thailand had a futures market, the Agricultural Futures Exchange of Thailand. But it was dissolved and absorbed into the wider futures exchange. Thailand had its own problem with a state procurement system on rice that destroyed its competitiveness, meaning that Thai rice fell to the number-two exporter behind Vietnam. Japan has well-developed futures exchanges on agriculture, and the Osaka Dojima Commodity Exchange has a seafood futures contract on frozen shrimp. But futures exchanges are not an institutional necessity for profitable agricultural or metals markets – Australian production of both occurs largely without recourse to exchanges for price-setting.
Photo courtesy of Future Risk