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TSI Market Watch: Iron Ore July 20, 2016

TSI 62% Fe benchmark usage in iron ore physical linkage rising, helping hedging

The TSI 62% Fe iron ore index is being used exclusively for index-linked spot deals of Jimblebar

Fines, a 61.3% Fe ore produced by Australian miner BHP Billiton, several market sources have

confirmed.

Prior to July, the product was reportedly sold in the spot market based on an average of TSI 62%

Fe and an index for 62% Fe fines produced by Argus Media. The first news of the exclusive use

of TSI’s index for physical linkage came via the two leading electronic trading platforms (COREX

and GlobalORE).

The decision to trial sales based purely on the TSI 62% Fe index, rather than an average, is

believed to be based on increased requests from customers who hedge their physical exposure

in futures markets. The TSI 62% Fe benchmark is used to settle more than 99% of all US$-

denominated iron ore derivatives.

As yet, it is unclear whether this will also be extended to long-term contracts for Jimblebar. One

Chinese steel mill located along the Yangzi River who buys the product said their current one-

year contract has not yet ended, but that they would be willing to switch to a “TSI only”

arrangement when it comes up for renewal. “It would be more convenient for us when hedging

in the derivatives market, and would lower our basis risk,” said a purchasing manager at the mill.

While much iron ore in the physical market is purchased against a range of other indices, using

different indices for physical and financial contracts creates basis risk for anyone who wishes

to offset risk in financial markets cleared against the TSI 62% Fe price. This is because month-

end averages between physical and financial settlement can be variable and unpredictable.

Using the same index for both the physical and financial sides of the deal removes this basis risk by ensuring the two legs match. The unpredictability of basis risk has long been an unwanted “wild card” element in any hedge, but is becoming more of a headache as trading margins come under pressure. The purpose of hedging is after all to remove risk.

There has also long been strong demand from end-users and traders for linkage to higher

volume ‘mainstream’ ore grades too, not just Jimblebar, for the exact same reason: more

effective hedging.

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Meanwhile, liquidity risk for “hedgers” has become a thing of the past as volumes of derivatives

continue to soar. Preliminary data for the first half of 2016 (H1) shows volumes of cleared

derivatives settled against the TSI 62% Fe number to be 101% above the level of H1 2015 (see

chart above). Indeed, liquidity across exchanges was just shy of a billion tonnes (976,083,800

tonnes) between January and June this year. To put this in context, last year those volumes

weren’t achieved until sometime in November.

Annualizing the preliminary exchange data now puts the ‘paper’ trade of iron ore at two times

the underlying physical Chinese market reference, as well as comfortably over the size of the

total global seaborne market for the first time.

Ends

For further information

Please contact:

Oscar Tarneberg(Shanghai) +86 21 5110 5468 o.tarneberg@thesteelindex.com

Note to Editors:

The Steel Index (TSI) is a leading specialist source of impartial steel, scrap, iron ore and coking coal price information based on spot market transactions.

Transaction price data is submitted confidentially to TSI on-line by companies buying and selling a range of relevant steel, iron ore, scrap, coking coal products. TSI’s index reference prices are then calculated using transparent and verifiable procedures which are fully aligned with IOSCO principles.

TSI’s iron ore and coking coal price indices are published daily at 18:30 Singapore/Shanghai time (10:30 GMT). Steel prices f or Northern Europe, Southern Europe and US HRC are published daily at 14:00 UK time and for ASEAN HRC imports daily at 18:30 Singapore time. Scrap prices for Turkish imports are published daily at 13:30 UK time. Weekly steel and scrap price indices are published every Monday and Friday res pectively, with each price representing the average transaction price for the previous calendar week.

TSI’s indices are widely used by steel mills, miners, traders, distributors and manufacturing companies worldwide as the basis for their physical pricing arrangements. TSI’s indices are also used as the industry standard in the settlement of ferrous financial contracts.

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Singapore Exchange (SGX), LCH.Clearnet (London), CME Group (Chicago), NASDAQ OMX Clearing (Oslo), European Energy Exchange (EEX) and Intercontinental Exchange (ICE) all use TSI’s iron ore index for settling their monthly cleared iron ore financial contracts. SGX a lso uses TSI’s coking coal indices and hot rolled coil index for ASEAN imports to settle its coking coal and Asian HRC steel futures and swap contracts respectively. In addition, TSI’s prices are used for the settlement of European hot rolled coil steel contracts on LCH.Clearnet and CME Cleari ng Europe, the settlement of Turkish scrap imports contracts on LCH.Clearnet, LME, CME Europe and Borsa Istanbul, and domestic US scrap and hot rolled coil steel contracts settle on NASDAQ OMX Clearing. In all cases, settlement prices are the average of TSI’s reference prices published in the expiring month.

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