Ethylene Over-The-Counter (OTC) Futures Contract
Ethylene is the primary building block used for a wide variety of petrochemical products such as plastics, polyesters, PVC etc. For instance, it is used in the production of polyethylene, ethylene dichloride (EDC), ethanol, styrene monomer (SM), glycols and many other products. Asia’s demand for ethylene is expected to grow by 10–12 million tonnes in the next ten years, or around 4–5 percent per annum.
What is Ethylene OTC Futures Contract?
The introduction of Ethylene OTC (Over-The-Counter) Futures Contracts offers the opportunity to market players to hedge against the risk of fluctuations in ethylene prices, which in recent times have seen prices hit nine-to-ten year highs due to tight market supply and strong Asian demand. It has hybrid features of Forward OTC and Futures contract.
| Forward (on OTC market) | Futures (on Exchange) |
| Traded on over-the-counter market | Traded on an exchange (Membership) |
| Small risk that the contract will not be honored | Clearing house guarantees performance of trade (Security margin required) |
| Not standardized (free to negotiate any mutually attractive deal) | Standardized contract |
| Settled at end of contract | Settled daily (mark-to-market) |
| Delivery or final cash settlement usually takes place | Contract is usually closed out prior to maturity |
Outline of Ethylene OTC Futures Market
This initiative was conceived as a solution to help ethylene producers, traders and consumers in Asia to reduce their price risk exposure and develop a more efficient market. Price risk can be reduced through hedging in derivative market, namely Ethylene OTC Futures market.
The idea of developing Ethylene OTC Futures contract was conceived to overcome the logistic constraints and fragmented olefin’s physical market by introduction of sophisticated cash settlement method, leading to enhancement of market liquidity. The financial settlement of these OTC Futures contracts could be benchmarked against daily ICIS-PRICING ethylene index (EIX).
This OTC Futures will in-turn give the producers, traders, consumers and even financial institutions to determine the market and thus create a more reliable or de-facto Asian index in the ethylene market.
Benefits of OTC Futures Contract
New Business OpportunitiesAs Marketing/Procurement Tool
| * | Lock in - Purchase price - Selling price - Margin |
| * | Hedge Inventory As Trading Tool |
| * | New Opportunity Time spread trade (Contango/Backwardation), Arbitrage trade etc |
Price Discovery
With convergence of all the buyers and sellers, we can create a more transparent environment that is often absent in over-the-counter (OTC) markets. The introduction to different groups of market participants with different views and needs leads to enhancement of market liquidity and the realization of a more efficient price discovery platform.
Key Elements of a Futures Contract
The contract terms of the Ethylene OTC Futures contract is standardised in terms of the contract size, delivery month and final settlement day.
Ethylene OTC Futures Contract Terms
Contract Code
FEIX
Underlying
ICIS-PRICING Ethylene Index (EIX) CFR N.E. Asia
Contract Size
500 metric tons.
The quantity is a predetermined size designed to suit a hedging instrument for most frequent size of cargo, 2,300–3,500 MT for spot trade in Northeast Asia.
Minimum Price Fluctuation
US$0.50 per metric ton.
The minimum price fluctuation indicates the minimum price movement allowed on either side of a contract. If the current bid price is US$1200.50, a better bid must be at least US$1201.00.
Daily Price Limits
10% above or below the preceding day settlement price for all contract months, except the prompt month.
Position Limit
50 contracts net long or net short in any one contract month or all months combined.
Contract Months
Prompt month and the next two calendar months.
Trading can be conducted 24 hours on an OTC basis. However, market contracts can only be presented to Bursa Malaysia Derivatives Clearing for registration during the following clearing sessions:
| * | First clearing session: Malaysian 10:00 – 11:00 |
| * | Second clearing session: Malaysian 14:30 – 17:30 |
Contract Maturity
The last Business Day of the month preceding the prompt month.
Settlement Type
The Final Settlement Daily Price methodology allows the ethylene market participants to better manage their price risk by using ICIS-PRICING EIX prices that are widely used by the physical market.
Final Settlement Price
The Final Settlement Price shall be based on the simple average of the last three daily ICIS-PRICING Ethylene Index (EIX) and rounded to the nearest US$0.50.
Initial/Spread Margins and Settlement-to-Market
Bursa Malaysia Derivatives Clearing’s risk management function is carried out routinely on a daily basis and is inherent in its clearing and settlement procedures. This involves the collection of initial/spread margins, settlement-to-market and payment procedures.
Initial /Spread Margins
Margins are required to be maintained with Bursa Malaysia Derivatives Clearing for each open position. Initial Margins can be lodged in US$ cash and/or letter of credit, or in major foreign currencies. Reduced Initial Margins are levied for spread positions. Prompt Month Spread is defined as a combination of long and short positions in different months where one of the months involved is the prompt month. Back Month Spread comprises a combination of long and short positions in different months where none of the months involved is the prompt month.
Settlement-to-Market
All open contracts are valued daily against the Daily Settlement Price and the resulting profits/losses (known as Variation Margin) are posted to the accounts of the Clearing Participants. Amounts due from Clearing Participants arising from this process are required to be paid in cash before the start of trading on the next business day. This process is an integral risk management practice because losses are not allowed to accumulate.
Daily Settlement
Bursa Malaysia Derivatives Clearing will determine the Daily Settlement Price for each open contract with reference to the ICIS-PRICING Ethylene Index (EIX), which will be determined by physical/paper spot prices and market fundamentals. The Clearing House reserves the right to exercise absolute discretion in determining the Daily Settlement Price at all times.
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Example of the Settlement-to-Market Process
| Date/Scenario | Variation Margin/ Settlement Profit/(Loss) | Comments |
| Day 1 Sells 1 Oct 07 Contract at US$1250/MT Daily Settlement Price of Oct 07 Contract: US$1247/MT |
Variation Margin: 500MT x (1250-1247) = US$1,500 Profit |
Client’s outstanding position will be carried forward to next trading day at revalued price of US$1247/MT Since the client has a profit position, no margin call is issued. |
| Day 2 Daily Settlement Price of July 05 Contract: US$1253/MT |
Variation Margin: 500MT x (1247-1253) = US$3,000 Loss |
Client’s outstanding position will be carried forward to next trading day at revalued price of US$1253/MT Clearing Broker will issue margin call for client to top up losses. |
| Day 3 Daily Settlement Price of Oct 07 Contract: US$1260/MT |
Variation Margin: 500MT x (1253-1260) = US$3,500 Loss |
Client’s outstanding position will be carried forward to next trading day at revalued price of US$1260/MT Clearing Broker will issue margin call for client to top up losses. |
| Day 4 Market falls on weaker upstream market and client decides to take profit. The client closes out the short position by executing a buy contract at US$1240/MT |
Settlement Profit: 500MT x (790-770) = US$10,000 Profit |
Settlement profit calculated against revalued price of US$790/MT |
| TOTAL PROFIT | US$1,500 - US$3,000 - US$3,500 + US$10,000 = US$5,000 | Total Profit (Difference between entry and exit prices): 500 MT x (1250-1240) = US$5,000 |
How it is done
To start trading, a market participant must appoint a registered Trading Broker to execute the Ethylene OTC Futures trades on an OTC basis. Matched trades or “Market Contracts” may then be presented to Bursa Malaysia Derivatives Clearing Bhd, which acts as the Clearing House to be cleared. Market participants have the choice of either clearing their Contracts directly with the Clearing House by becoming a Special Clearing Participant (“SCP”), or through a participating General Clearing Participant (“GCP”) (also known as a Clearing Broker).
Market Contracts presented to the Clearing House are registered, and immediately upon the registration of each Market Contract, two new contracts (“Open Contracts”) are created in place of and on identical terms with each Market Contract. The Clearing House becomes the buyer to the Clearing Participant acting as the seller under one Open Contract and the seller to the Clearing Participant acting as the buyer under the other Open Contract.
As a counterparty to all open contracts, the Clearing House undertakes to its Clearing Participants who are party to those Contracts that it will perform its financial obligations under the Contracts. This undertaking is backed by the Clearing House’s risk management system and procedures as well as funds held for such purpose.
Trade Overview
In case of market participant clearing through a GCP (Clearing Broker).
Criteria for Membership to Bursa Malaysia Derivatives Clearing
Market users wishing to clear their ethylene contracts directly with Bursa Malaysia Derivatives Clearing are required to sign an OTC Clearing Service Agreement (“Clearing Agreement”) for admission as a Special Clearing Participant (“SCP”). Alternatively a user can use the services of a participating General Clearing Participant (“GCP”).
| * | initial fixed contribution of US$ 0.25 million in cash to the clearing fund. SCPs will need to make variable contribution to the clearing fund in the event Bursa Malaysia Derivatives Clearing requests for additional contribution to the clearing fund; and |
| * | contribution of US$ 0.25 million in stand-by L/C as Security Deposit. |
On becoming a Clearing Participant of Bursa Malaysia Derivatives Clearing, the SCP also undertakes to comply with the Provisions of the Clearing Agreement.
Citibank’s Cash Management Structure
Account Structure| * | The Clearing House will open a main account with Citibank Berhad in Kuala Lumpur, Malaysia. |
| * | Sub-accounts will be created for respective clearing participants and linked to the Clearing House’s main account with Citibank Berhad, Kuala Lumpur, Malaysia. |
Payment Instruction
| * | On settlement date, the Clearing House will provide electronic payment instructions to Citibank on the settlement-to-market amounts due from clearing participants. |
| * | Citibank will effect transfers between the Clearing House and the respective sub-accounts by debiting or crediting the sub-accounts. |
| * | Citibank will advise the Clearing House on the settlement status on a daily basis. |
Information Delivery
| * | Respective participants will be provided customized access via Citibank Corporate Internet Banking to view all transactions on a real-time basis in relation to the operation of the accounts maintained under the account structure with the Clearing House. |
| * | Access to Citibank Corporate Internet Banking is not restricted to business hours but is accessible 24 hours a day and all days of the week. Clearing Participants are able to acces Citibank Corporate Internet Banking (www.citibank.com/malaysia/corporate) wherever they are as long as there is a PC or laptop and Internet access. |
Guiding Principles for the Ethylene Index (EIX)
ICIS-PRICING’s methodology for the Ethylene Index (EIX) is based upon the guiding principles of simplicity and objectivity.
The EIX will be used as the final settlement price and daily “mark-to-market” assessment prices for all ethylene trades cleared by Bursa Malaysia Derivatives Clearing for each trading day. The EIX will be assessed based on:-
* Physical spot trades
* Over-the-counter (OTC) futures contracts.
* Bids and Offers/Market fundamentals
Methodology Summary
- Calculation of the EIX:- The front-month EIX will primarily be based on an average of physical trades and OTC futures contract trades. In the absence of physical trades, bids/offers and previous day’s trades from OTC futures contracts/physical trades will be used to form the EIX.
The EIX front-month (prompt month), for the forward 16–45 day trading period, will be closely aligned with physical markets in order to minimize basis risk. All values in the index will be rounded to the nearest US$0.50/mt.
The calculation of the EIX is deemed separate from other ICIS-PRICING daily and weekly market price assessments. Physical transactions to be accepted into the EIX are ideally supported by confirmation from buyer and seller, if not, well-supported by extensive market sourcing and in line with market fundamentals and trends. ICIS-PRICING retains the right not to include any deal which is believed to be manipulative or has been negotiated in specific circumstances. ICIS-PRICING also reserves the right to exclude any deal which is believed to have been negotiated in distressed circumstances.
- Publishing and distribution:- The EIX will be published at 1830 Singapore/Malaysia time on each working day for market assessments.
- Volumes:- Standard sized lots 2,300–3,500 mt for physical, and 500 mt for OTC futures contracts are used for assessment of the EIX. Larger-sized parcels may also be considered for assessment.
Contract Specifications
| Contract Code | FEIX |
| Underlying | EIX (ICIS-PRICING Ethylene Index) CFR N.E. Asia |
| Contract Size | 500 metric tons |
| Minimum Price Fluctuation | US$0.50 per metric ton |
| Daily Price Limit | 10% above or below the preceding day settlement price for all contract months, except the prompt month |
| Position Limit | 50 contracts net long or net short in any contract month or all months combined. |
| Contract Months | Prompt month and the next two calendar months |
| Clearing Hours | First clearing session: 10:00am to 11:00am Malaysian time. Second clearing session: 2:30pm to 5:30pm Malaysian time. |
| Trading Hours (Last Trading Day) | Trading terminates at the end of clearing hours on the last business day of the month preceding the prompt month |
| Contract Maturity | The last business day of the month preceding the prompt month |
| Settlement Type | Cash settlement based on the Final Settlement Price |
| Final Settlement Price | Final Settlement Price shall be based on the simple average of the last three daily EIX of the month preceeding the prompt month and rounded to the nearest US$0.50 |
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