China's securities regulator said on Friday it had approved the launch of hog futures by the Dalian Commodity Exchange (DCE) in a long awaited move for the world's top pork producer.

The China Securities Regulatory Commission (CSRC) said in a statement on its website that the new futures contract would help players in the market worth nearly 1 trillion yuan (140 billion U.S. dollars) to manage risk, while helping the sector to develop.

Market analysts pointed out that by participating in futures trading, relevant industrial enterprises will promote the effectiveness of price discovery of hog futures and provide the market with an open, transparent and continuous price reference, which is conducive to breeding enterprises to optimize resource allocation, reasonably control breeding scale, and promote the healthy development of the entire industry.

Farmers in China, home to about half of the world's pigs, produce around 50 million tonnes of pork a year, typically face a highly cyclical market. The arrival of African swine fever in 2018, which killed millions of pigs and sent pork prices to record highs in October 2019, added to the volatility.

Can the 'hog cycle' be stabilized?

Since 2003, China's hog prices have experienced five major fluctuations, generating five hog cycles. Especially since August 2018, due to the African swine fever epidemic, a series of changes have taken place in China's live pig market. 

The price of live pigs fell from 15 yuan per kilogram to 10 yuan per kilogram in March 2019, and then rebounded significantly in the third quarter of 2019, reaching a historical high of nearly 40 yuan per kilogram. 

The violent fluctuations in the spot price of live pigs bring great uncertainty to industrial enterprises, and production and operation are difficult to stabilize, which is not conducive to the healthy development of the industry.

However, now with hog futures approved, "it will provide a very good tool to hedge," said a manager at a major pig producer about the new futures contract. "Pig prices are quite high now, but it will not remain like this."

The exchange has previously noted the complexity of developing a financial derivative based on a live animal, particularly in a market where small-scale farming is still widespread and where there is little uniformity of breeds or farming practices.

But African swine fever has caused a huge upheaval, significantly reducing the market share of smaller players that were unlikely to use sophisticated hedging tools.

"Now the bigger players are investing so much in building new farms. They're in a position to say, we want to manage the risk, we should probably push forward with this," said Darin Friedrichs, senior Asia commodity analyst at broker INTL FC Stone.

The DCE said in a statement the standardization of hog breeds was increasing, and with most large producers using similar piglet supply, feed and technical services, slaughtered pigs and lean meat rates were also more uniform.

Details on the contract specification will be made public at a later date, a DCE spokeswoman said, but it is understood that the contract will by physically delivered.

A person who participated in an information session organised by the exchange last year said sellers would be limited to a small number of pre-approved large-scale hog producers to reduce the risks of any impact from African swine fever, which is still circulating.

Long step 

The history of China considering hog futures can be traced back as early as 2001. 

The DEC applied for regulatory approval for the contract three years ago, after spending more than a decade researching similar products.

In 2006, the State Council mentioned for the first time the adoption of futures trading and other measures to steadily develop the pig industry, and would choose an appropriate time to launch live pig futures trading as soon as possible.

In the past two years, market discussions on the listing of hog futures have increased and new progresses have been achieved gradually. In February 2018, the CSRC officially accepted the application of the DEC's hog futures project.

At the 15th China (Shenzhen) International Futures Conference held at the end of 2019, Fang Xinghai, vice chairman of the CSRC, said the committee will strive to achieve listing of hog futures as early as possible," and Li Zhengqiang, party secretary and chairman of the DCE, said that "the DEC will accelerate the listing of hog futures."

(Cover image via VCG)

(With input from Reuters)