Why exchanges bought into GDT deal

Stu Davison looks at the Global Dairy Trade partnership and what this means for New Zealand dairy.

In Business6 Minutes

Stu Davison looks at the Global Dairy Trade partnership and what this means for New Zealand dairy.

In late February, Fonterra announced that they have struck an agreement of partnership with both the New Zealand Exchange (NZX) and the European Energy Exchange (EEX) in ownership of the Global Dairy Trade platform (GDT).

This may come as a bit of a surprise to most, potentially from two angles: not knowing Fonterra owned the GDT platform, to the fact that Fonterra divested two-thirds of its ownership in GDT itself.

Let’s dive into why this partnership helps to build the GDT platform, and why the two exchanges would be interested in GDT in the first place. The bi-monthly GDT auction settles the dairy ingredient commodity futures contracts for the SGX-NZX Dairy Derivatives market. So, if a futures contract is struck between buyer and seller on the SGX-NZX Dairy Derivatives market for a certain month, let’s say a March whole milk powder (WMP) contract, then during the March GDT auctions, a market price for the WMP is calculated.

This is derived using the average of the second contract period price for a particular grade of product from each auction. So, in this format, the GDT auction is being used as a transparent way for both sides of the marketplace to see what the true market price of WMP is, and thus fairly settling the futures contract that both sides entered.

This means exchanges that list the dairy derivatives are relying on another company’s auction platform to settle their financial instruments, potentially creating some misalignment, and creating problems for the exchanges. So, for the exchanges involved, it helps to bring some certainty to their own operations, but also to the customers using their listed financial instruments.

Secondly, this partnership allows the two exchanges to potentially create new dairy derivatives, to add to the list of ingredient derivatives already on offer.

The GDT auction allows the entire market to understand the direction and magnitude of the dairy complex, by having regular insight into what is happening to physical prices, something that would normally happen behind closed doors by salespeople and the buyers, and not see the light of day.

This means the marketplace can register a potential risk to their own business from a rising or falling market and decide if they need to mitigate their risk through a derivative contract, be that a futures contract or an options contract. This obviously helps the exchanges, as it helps derivative users decide if they need to trade financial instruments.

How does this help Fonterra, and why would Fonterra sell the GDT platform? Fonterra is the biggest seller of dairy commodities on the GDT platform, while also owning the same auction platform, which could create a touch of distrust to some buyers in the marketplace. So, this new partnership hopefully creates more trust from the buy side, as they now see it’s not just Fonterra involved in the GDT platform and can trust that this auction place is always going to be trustworthy.

Secondly, Fonterra is the biggest seller of dairy derivatives via the SGX-NZX Dairy Derivatives market, purely due to Fonterra’s market size in NZ. These futures and options contracts are then settled via its own auction platform; not really ideal if you start looking at it with some skepticism. However, it is extremely important to Fonterra to be able to manage its risk via the SGX-NZX Dairy Derivatives market, thus why it needs to keep the GDT auction at arm’s length, while also hoping for the auction, and the derivatives market, to grow to allow for more risk management.

Through this new partnership, where Fonterra doesn’t own the entire platform, Fonterra realises the potential for more volume to be traded through the GDT process.

Other processors can also offer large volumes of dairy products on the regular auctions, which allows for more price discovery for the marketplace.

NZX and the EEX can now help to bring this new volume to the GDT platform, through trusted partnerships, along with geographical locations. EEX is ideally placed to be able to bring more European dairy to the platform, which would provide massive price insights into the largest dairy exporting bloc in the world.

All of these factors combine to create a very exciting future for the dairy industry, potentially reducing volatility in the market, increasing the availability of risk management tools, while helping all businesses exposed to the global dairy industry see what the market is doing.

  • Stuart Davison is an NZX Dairy Analyst.