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1
Introduction 2
Dairy Commodities 4
Global Dairy Market 5
Futures - The Basics 6
Using Dairy Futures - Value To Customers 9
Using Dairy Futures - To Manage Risk 11
Dairy Market Information and Data 13
Contract Specification 14
Getting Started 15
DISCLAIMER
The information contained in this document is a guide only. This publication is for information only and does not constitute an offer, solicitation or recommendation to acquire or dispose or an opinion related to acquiring or disposing of any financial product, investment or to engage in any other transaction. Those wishing either to trade in or to clear or settle any products made available by NZX Limited (NZX) or its subsidiaries, including New Zealand Clearing and Depository Corporation Limited (NZCDC) and its subsidiaries, or to offer and sell them to others should consider their legal, tax, financial and regulatory position, including the relevant market rules, and the risks associated with such products before doing so. All information, descriptions, examples and calculations contained in this publication are for guidance purposes only, and should not be treated as definitive. Participation in, and trading on, any NZX market or NZCDC’s clearing house is subject to compliance with the relevant rules and procedures, and this document is not a substitute for those rules. No part of this publication may be redistributed or reproduced in any form or by any means or used to make any derivative work without written permission from NZX. NZX (including its subsidiaries, and its and their respective directors, officers, employees, contractors and agents) shall not be liable (except to the extent required by law) for the use of the information contained in this document however arising in any circumstances connected with trading, clearing and settlement or otherwise. NZX is not responsible for any errors or omissions contained in this publication.
NZX Limited © 2010
CONTENTS
2
This guide provides information on dairy commodities and the dairy
industry, NZX Dairy Futures (how they might be used to manage risk
or to invest) and where and how to trade Dairy Futures.
NZX Limited (NZX) is a dynamic market operator with integrated services in information, markets and
markets infrastructure.
NZX is the hub of trading in New Zealand debt and equity markets, bringing buyers and sellers together through
its Trayport GlobalVision electronic trading platform. World class clearing and settlement services will be
provided by NZ Clearing Corp.
Futures trading at NZX will initially be centered around Dairy Futures.
NZX believes information is a core building block in the successful development of markets. To support Dairy
Futures, we have integrated a wide range of news and data services, for agricultural commodities under our NZX
Agri brand. See page 11 of this guide for more information.
Introduction
DAIRY FUTURES GUIDE - ESSENTIAL INFORMATION
Dairy products are amongst the most important of all traded food products. Milk matters to people everywhere. Traded dairy
products are equally fundamental and trade is dominated by a few particular dairy commodities: Whole Milk Powder (WMP), Skim
Milk Powder (SMP), Butter, Anhydrous Milk Fat (AMF) and Cheese.
Of these, WMP and SMP are the most basic and important - containing all the vital proteins. New Zealand is a major global
player in these products, exporting 95% of its milk production in the form of dairy commodities1. Nearly half of all WMP exports
come from New Zealand.
1 Source: Dairy NZ, 2010
Dairy Commodities
Milk Powder
Milk powder manufacture involves the gentle removal of water
under stringent hygiene conditions, retaining all the desirable
natural properties of the milk - colour, flavour, solubility and
nutritional value. Whole (full cream) milk contains, typically,
about 87% water and skim milk contains about 91% water.
During milk powder manufacture, this water is removed by
boiling the milk under reduced pressure at low temperature in
a process known as evaporation.
The resulting concentrated milk is then sprayed in a fine
mist into hot air to remove further moisture, resulting in a
fine powder.
Milk is a perishable product. Milk is processed into finished
goods such as dried milk powder that can be stored for several
years and is traded globally.
New Zealand manufactures more than 100 varieties of spray-
dried milk powder to meet the diverse and special needs of
customers. Milk powders may vary in their gross composition
(milk fat, protein, lactose), the heat treatment they receive
during manufacture, powder particle size and packaging.
Special “high heat” or “heat-stable” milk powders are required
for the manufacture of certain products such as recombined
evaporated milk.
Milk powders of various types are used in a wide range of
products such as baked goods, snacks and soups,
nutritional drinks, chocolates and confectionery, ice cream
and infant formulae.
Approximately 13 kg of WMP or 9 kg of SMP can be made
from 100 litres of whole milk.
DAIRY FUTURES GUIDE - ESSENTIAL INFORMATION
3
4
Global demand for protein has been rising for some time.
Demand for protein is very income-sensitive. Rising income
levels in emerging markets have led to changes in diet,
incorporating more meat, eggs and milk. In recent years, the
strongest growth in consumption of dairy products has come
from emerging Asian markets, particularly China.
On the supply side, some major producing countries such
as the US or India can move from being a net exporter to a
net importer of dairy over short periods of time. Adding yet
more volatility to the picture is the bank financing cycle. Cows
represent major capital expenditure for farmers, and banks
have moved from a cycle of easy to tight credit in
dairy farming.
Volatility in the global dairy industry has been unprecedented
over the last five years. This is widely expected to continue as
global demand increases on the back of a growing awareness
of milk’s nutritional value and improvement in living standards
in developing economies (and demand for proteins), including
large players like China. This volatility, as a result of the spike in
demand and multiple unpredictable supply side factors, creates
a difficult operating environment for all those in the dairy
supply chain.
Globally, dairy trade is worth an estimated US$140 billion
annually1. This figure represents a variety of end products
including liquid and powdered milk. The export market is
dominated by milk powder. With over US$13.8 billion of Whole
Milk Powder (WMP) produced globally in 2009, WMP dominates
the milk powder export market and is the pricing benchmark for
the dairy industry worldwide2.
1 Source: FAOSTAT, 2007 2 Source: Global Trade Atlas, 2009
Global Dairy Market
DAIRY FUTURES GUIDE - ESSENTIAL INFORMATION
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globalDair y T rade average WMP spot contract Agrifax WMP
Graph: Whole Milk Powder Prices
5
The primary advantages of the NZX Dairy Futures market are:
The ability to manage risk through the creation of price certainty (hedge);
Price discovery, creating market transparency; and
Forward view of market sentiment.
In order to understand Dairy Futures, it is important to
understand some basics about derivatives. If you are an expert,
skip this section. Simply, futures and options are financial
products known as derivatives.
Derivatives: A derivative is a risk transfer agreement,
the value of which is derived from the value of an underlying
asset. A Dairy Future is in effect, a risk transfer agreement,
the value of which is derived from the value of a dairy
commodity product traded in the physical dairy market, such
as WMP or SMP.
Futures: A futures contract is a legally binding contract
to buy or sell a standardised product, at a fixed price, for
cash settlement or physical delivery on a given date in
the future. In the case of Dairy Futures, the standardised
product is the dairy commodity from which it is derived. For
example, a Global WMP Future is a legally binding contract
to buy or sell WMP at a fixed price for cash settlement in the
future. The same is true of a Global SMP Future.
Options: An option is the right, but not the obligation, to
buy or sell something at a fixed price in the future. This price
is called the “strike price”. There are two types of options:
A – call option gives the holder of an option the right but
not the obligation to buy the underlying asset at the
strike price; and
A – put option gives the holder of an option the right but
not the obligation to sell the underlying asset at the
strike price.
An option on a future (e.g. a Global WMP Option), gives the
holder of an option the right, but not the obligation, to buy or
sell a Global WMP Future at a set price in the future.
NZX Dairy Futures Market
As a futures exchange, NZX is the central marketplace in
New Zealand that facilitates the trading of futures between
participants. An efficient robust market supported by a world
class clearing system (NZ Clearing CorpTM) participants
can be assured of transparency and strong risk management
when they trade with NZX.
The NZX Dairy Futures market allows participants to manage
price risk by creating opposing positions in the futures and
physical market, effectively neutralising any movement in price.
Participants can open a position by buying or selling and close a
position by carrying out an opposing trade, i.e. open with a sell,
close with a buy.
NZX Dairy Futures will be exchange listed and cash settled to
globalDairyTrade (gDT) prices. Cash settlement of a futures
contract means trading is much simpler and easier. Participants
do not have to implement complicated delivery mechanisms
or risk having to make, or take, delivery of the underlying
product to which the futures contract relates. Cash settlement
is particularly preferable for dairy commodities where food
safety criteria, and the actual delivery process, are complex and
not globally standardised.
An important aspect of futures markets is that while they are
representative of the price of the physical product (e.g. WMP),
they operate separately to trading activity in the physical
market regardless of the way the contract is settled. Futures
markets are not generally used as a means to buy or sell
physical product.
Futures - the basics
DAIRY FUTURES GUIDE - ESSENTIAL INFORMATION
6
Standardised futures contracts have set expiry dates. In the
case of Global WMP Futures, the contracts will expire each
calendar month. Global WMP Futures will be cash settled. Cash
settlement is the difference between the price at which the
trade was entered and the reference price at expiry.
All NZX Dairy Futures will be cash settled.
NZX selected cash settlement rather than physical delivery for
NZX Dairy Futures as physical delivery can restrict participation.
Cash settled futures contracts are much simpler, and enable
much wider and deeper participation.
NZX Dairy Futures Product Set
The NZX Dairy Futures market is intended to have as its
baseline product set:
Global Whole Milk Powder (WMP) Futures;
Global Skim Milk Powder (SMP) Futures;
Global Anhydrous Milk Fat (AMF) Futures; and
Options against both the WMP and SMP Futures
The first product to be launched will be the Global WMP Future.
Each of the NZX Dairy Futures will have as their reference
price the price set on the globalDairyTrade (gDT) auction. As
stated earlier, NZX Dairy Futures will have expiry dates and the
contracts will expire each calendar month.
Futures - the basics CONTINUED
DAIRY FUTURES GUIDE - ESSENTIAL INFORMATION
7
Using Dairy Futures - value to customers
A wide range of participants in the dairy and financial sectors
can benefit from using NZX Dairy Futures. Some of the largest
groups are outlined below.
Dairy Processors
For any dairy processor the foundation to its business is the
ability to secure, retain and increase the supply of milk. Providing
certainty in advance over the price paid for either all or part of
that milk supply means the processor can make investment and
production decisions ahead of time with a much greater degree
of confidence. The ability for a processor to provide fixed price
contracts to farmers will undoubtedly be a drawcard in retaining
supply and attracting new farmers.
Dairy Buyers
Providing certainty in advance over the price received/paid for
dairy commodities means the processor and the purchaser can
better plan for the future and have confidence over sales and
delivery of product. This certainty helps to retain and grow the
purchaser customer base and means the processor can lock in
price for supply. Locking in revenue lines means you can also
lock in cost lines.
Farmers
Farmers are the bedrock and most important players in the
industry. As one farmer said to us “cows are machines for
turning grass (or grain) into milk”. For each litre of milk produced,
depending on where in the world they farm, that litre will go to
produce a mix of WMP, SMP, AMF, cheese, or other value added
product. The prices for the ingredients - WMP, SMP, AMF are all
highly correlated. If the price for WMP falls today, the amount of
money farmers receive as a payout will also fall shortly. There is
a definite and strong correlation between the price of WMP and
the payout farmers receive for their milk. NZX Dairy Futures, in
particular, the Global WMP Future, will for the first time provide
farmers with a daily, transparent indication of sentiment around
dairy commodity prices, and provide the opportunity to lock in
a portion of production. By using Global WMP Futures to hedge,
farmers can take the downside risk out of their cash flow
position. While their processor may also hedge, Global WMP
Futures give farmers control of their cashflow, and assist them to
minimise downside.
Banks
Banks in rural countries and communities have a direct line into
agriculture. Around the world, banks work with farmers to provide
lending facilities, as well as hedging tools for currency and
interest rates. Banks, like their customers, like to have stable
cash flows, and to reduce payment risk as far as possible.
Given the volatility in the milk price, and hence in farmers’ cash
flows, NZX Dairy Futures will give banks a product they can
provide to farmers. Improving cash flow certainty is in both the
banks’ and farmers’ best interests. At a macro level, banks
around the world have a significant amount of capital allocated to
the dairy sector. NZX Dairy Futures provide products for banks to
manage their portfolio exposure to the dairy sector as a whole.
Funds
More and more funds are starting to recognise the importance
of dairy to the global political economy and as a traded product.
NZX Dairy Futures provide funds with a product set to gain
exposure to long-term trends in dairy and demand for proteins,
and thus to expand their portfolios to include this very
important sector.
DAIRY FUTURES GUIDE - ESSENTIAL INFORMATION
8
Using Dairy Futures - to manage risk
NZX Dairy Futures are designed to manage risk and smooth
out volatility and are intended to create price certainty,
transparency and a forward view of market sentiment.
By trading on the NZX Dairy Futures market, participants can
create price certainty. The ability to create price certainty for
a participant is a fundamental competitive advantage in a
volatile market. For a processor, hedging ensures certainty
for themselves and the farmer over prices paid for liquid milk,
as well as certainty over forward sales prices. This hedging
activity also offers purchasers the ability to secure supply and
manage their own price risk, providing certainty over future
purchase prices.
Price certainty is achieved by entering equal and opposite
positions in the physical and futures markets. Any loss in the
physical market will be offset by a profit in the futures market
and vice versa (physical and futures market prices tend to
move together i.e. mirror each other). The purpose is not to
make a profit or avoid a loss in either market, but to lock in
price ahead of time.
Hedging Examples
NZX Dairy Futures are tools to manage price risk through
the practice of hedging. Hedgers are not attempting to beat
the market; the purpose of hedging is to lock in a price. The
following are examples only, and are not a recommendation or
the giving of an opinion relating to the acquisition or disposal
of NZX Dairy Futures.
In the NZX Dairy Futures market a participant can open a
position by buying or by selling.
Producers (sellers) are effectively “long” in the physical WMP
market before they fix a delivery price with buyers. Buyers are
effectively “short” in the physical WMP market before they fix
a delivery price with sellers.
See hedging examples over page.
Sell = Short hedge
Buy = Long hedge
A producer is at risk of the price falling.
A buyer is at risk of the price rising.
DAIRY FUTURES GUIDE - ESSENTIAL INFORMATION
9
Short hedge example: (Zero basis and fees)
Suppose it is April and a producer decides to hedge WMP to be sold in August because there is a risk the price could fall.
(Remember that futures and cash prices move in a similar direction and so a profit in one market is offset by a loss in another).
The producer sells one August Global WMP Futures contract at USD3,900/t.
If the price declines in the futures and cash market (as they tend to move in the same direction):
August Futures PriceProfit/Loss on
Futures
WMP Physical (Cash)
Price
Profit/Loss on
Physical (Cash)Net Purchase Price*
USD3,700/t +200 USD3,700/t -200 USD3,900/t
USD3,400/t +500 USD3,400/t -500 USD3,900/t
If the opposite happens, i.e. futures and cash market prices rise:
August Futures Price Profit/Loss on
Futures
WMP Physical (Cash)
Price
Profit/Loss on
Physical (Cash)
Net Purchase Price*
USD4,400/t -500 USD4,400/t +500 USD3,900/t
USD4,100/t -200 USD4,100/t +200 USD3,900/t
In both of the above scenarios, the gain/loss in one market is offset by a loss/gain in another. Therefore, in either of the above,
the producer has created price certainty for themselves ahead of time.
Using Dairy Futures - to manage risk CONTINUED
Sell High, Buy Low
DAIRY FUTURES GUIDE - ESSENTIAL INFORMATION
10
Using Dairy Futures - to manage risk CONTINUED
Long hedge example: (Zero basis and fees)
Suppose it is April and a manufacturer decides to hedge WMP to be bought in August because there is a risk the price could rise.
The manufacturer buys one August Global WMP Futures contract at USD3,900/t.
Assume the price rises in the futures and cash market:
August Futures Price Profit/Loss on
Futures
WMP Physical (Cash)
Price
Profit/Loss on
Physical (Cash)
Net Purchase Price
USD4,400/t +500 USD4,400/t -500 USD3,900/t
USD4,100/t +200 USD4,100/t -200 USD3,900/t
If prices decline:
August Futures Price Profit/Loss on
Futures
WMP Physical (Cash)
Price
Profit/Loss on
Physical (Cash)
Net Purchase Price
USD3,700/t -200 USD3,700/t +200 USD3,900/t
USD3,400/t -500 USD3,400/t +500 USD3,900/t
The goal of the hedger is not to beat the market but to create price certainty ahead of time. Therefore in either case the loss in
one market is offset by the gain in another, effectively setting a price ahead of time.
Buy Low, Sell High
DAIRY FUTURES GUIDE - ESSENTIAL INFORMATION
11
When hedging, a participant takes into account factors such
as the cost of trading (exchange and broker fees),
the cost of access to market (networks and software),
capital dedicated to margin and the liquidity of the product
traded. A risk management strategy can be designed to
achieve the participant’s goals, and the hedge can be
managed throughout its life to ensure optimal performance
in a dynamic and volatile market.
Futures prices are mainly driven by prices in the physical
(cash) market, however information and data points which
support views on future price movements are essential.
NZX provides a multitude of key data points, views and
commentary to help traders price NZX Dairy Futures.
gDT Data
NZX Dairy Futures will be accompanied by a direct feed
of gDT data from the gDT platform. The data on the NZX
data feed will include current and historical data. Users
of NZX data can be sure to have the latest, most current
information, equal with any direct user on the gDT platform.
Agrifax
Agrifax is New Zealand’s leading provider of independent
information for the agribusiness sector. It provides timely
and accurate data, insightful analysis as well as monitoring
services for global market trends and commodity prices.
Leading manufacturers, exporters, importers, economists,
financial and farm advisers and farmers in New Zealand and
internationally subscribe to Agrifax.
Click here to see Agrifax Dairy Reports:
http://www.nzxagri.com/agrifax
Agri Inform
Agri Inform produces NZ Dairy Exporter, Dairy Week,
New Zealand Farmers Weekly and many more weekly and
monthly news publications. All are respected for leading
the way in the provision of management information and up
to date news of value to the dairy industry and the wider
agribusiness sector. Click here for more information:
http://www.nzxagri.com
Australian Crop Forecasters
ACF publishes monthly subscription reports on
Australian grain supply and demand. Australian Crop
Forecasters has a long standing in the Australian grain
market as the lead provider of high quality and independent
crop forecasting services.
Click here to see a range of ACF reports:
http://www.cropforecasters.com.au/
Dairy Market Information and Data
DAIRY FUTURES GUIDE - ESSENTIAL INFORMATION
12
GLOBAL WMP FUTURES
Unit of Trading 1 tonne (MT)
Price basis USD/tonne
Minimum Price Movement
(Tick Size and Value)
$5 per tonne ($5)
Daily Price Limits 10% above or below the previous Trading Day’s Daily Settlement Price
Contract Months Every calendar month out to 18 months are available for trading
Trading Hours 08:00 hrs - 16:00 hrs NZST/NZDST
Last Trading Day Trading shall terminate on the last business day preceding the first gDT Auction of the
month i.e. trading in the March WMP Futures Contract will expire on the last Business
Day immediately preceding the first gDT Auction in April (See Expiry Calendar contained
in the Contract Terms and Administrative Procedures - NZX Derivatives Market Contract
No 1 (“Contract T&Ps”))
Final Settlement Cash settled to the Final Settlement Price calculated by NZX according to an average
of winning prices for Whole Milk Powder, Regular - NZ, Contract 1 in gDT Auctions as
stipulated in the Contract T&Ps
Clearing House New Zealand Clearing Limited
Common Trading Facilities Block Trading Facility √
Exchange for Physicals Facility √
Exchange for Swaps Facility √
Common Trading Facilities
Minimum Volume Thresholds
Minimum Volume Thresholds for each Contract or Class of Contracts are specified in
Part B Appendix One of the Procedures
Exchange Code WMPF
View vendor codes
Cross Transactions Minimum Time
Period
15 seconds
Position Limits 20,000 Open Positions in any Contract Month
Exchange Rule The Contracts are Traded on the NZX Derivatives Market and subject to the NZX
Derivatives Market Rules and Procedures
Contract Specifications
DAIRY FUTURES GUIDE - ESSENTIAL INFORMATION
This is an Individual Contract Specification for the purpose of the NZX Derivatives Market Rules (“Rules”) as amended or supplemented from time to
time. Capitalised terms used herein have the meanings given in the Rules, Procedures and the Contract T&Ps unless otherwise defined. The information
published here does not substitute the Rules, Procedures or Contract T&Ps. This Individual Contract Specification shall not constitute investment advice
nor an offer, invitation, solicitation or recommendation to engage in any transaction. NZX and its subsidiaries take no responsibility for any errors or
omissions or losses, direct, consequential or otherwise arising from actions based upon this information. Before entering into any transaction you
should take steps to ensure that you understand the transaction and have made an independent assessment of its appropriateness in light of your own
objectives and circumstances. You should also consider seeking advice from independent advisers. globalDairyTrade “gDT” is an internet-based electronic
trading platform for cross-border trade in physical commodity dairy products operated by an independent trading manager. For further information on
globalDairyTrade go to www.globaldairytrade.info © NZX Limited 2010 all rights reserved
13
To trade NZX Dairy Futures, you must trade through an NZX
accredited broker. A list of accredited NZX Derivatives Market
Participants is available on www.dairyfutures.com.
Once you have chosen a participant, you will need to open an
account with that participant. Those participants may offer
advice and in many cases may provide you with electronic
trading software for trading and data purposes.
Firms wanting to become an accredited NZX Derivatives
Market Participant must choose the participant status most
appropriate to their business model. All trades on the NZX
Derivatives Market must be cleared through an NZ Clearing
Corp accredited Clearing Participant. Financial Institutions
and Firms can choose to become accredited as a clearer
themselves, or clear trades through a third party clearer - a
General Clearing Participant. For additional information on
NZX Derivative Market Participant categories and NZ Clearing
Corp applications, please go to www.nzx.com.
NZX understands that, with increasing volatility in the dairy
industry and the emergence of new risk management tools
like NZX Dairy Futures, there is a great need for traders and
participants to become comfortable with using these tools.
Please visit our website www.dairyfutures.com to access
other materials that can help you to become better informed
about trading NZX Dairy Futures.
Getting Started
DAIRY FUTURES GUIDE - ESSENTIAL INFORMATION