Getting the global price right

Earlier this year, Bank of China became the first Chinese bank to join the auction process that sets gold prices in the London market, run by ICE Benchmark Administration.

These initiatives by Chinese banks are happening at a time when Western banks are retreating from the commodity trading sector due to declining profitability in the sector and increasingly stringent financial regulations following the 2008 financial crisis.

Most of these financial regulations demand stricter capital requirements for banks, such as Dodd-Frank, EMIR, and Basel III, and limits on proprietary trading by banks, such as the Volcker Rule.

Last year, Barclays said it would give up most of its metals trading, and JPMorgan agreed to sell its physical commodities business to Mercuria, a Swiss commodities trading firm.

Chinese banks' bigger balance sheets mean on average they have more capacity for commodity trading while still meeting the requirements, Clarke said.

"Chinese banks trading in this space have bigger balance sheets to start with than other banks, so the overall risk from such activities may be lower. Potentially, the returns for Chinese banks may be higher, or pricing keener, if the cost of capital used for such trading activities is lower than other banks," Clarke said.

Meanwhile, China is also setting up its own commodity exchanges to allow Chinese buyers and sellers to trade on a platform in their own time zone, and in a market which they are more familiar with.

Because commodity exchanges in China have trades denominated in yuan, Chinese participants are not subject to exchange risks or capital controls that they would face by participating in overseas exchanges.

China has three key commodity exchanges, the Shanghai Futures Exchange, established in 1999; the Dalian Commodity Exchange, established in 1993; and the Zhengzhou Commodity Exchange, established in 1990. None allows foreign participation because of China's capital controls.

Fang Jian, a partner at the London-based law firm Linklaters, said that China's three biggest domestic exchanges are all exploring how they can best open up to foreign trading. It is possible that the government will eventually allow foreign traders, who meet certain criteria, to take part.

"What the Chinese regulators are doing is realistic. The process of liberalization for commodity trading in China may be quite similar to the process of gradually allowing qualified foreign institutional investors to participate in China's stock market," Fang said.

Despite the Chinese commodity exchanges being relatively young, they have already gained significant influence in the commodity industry because of the massive volume of trade in the country.

They are also increasingly providing benchmark prices for commodities in their respective sectors, according to Daniel Morgan, global commodity analyst at UBS.

For example, iron ore traders now look to the Dalian Commodity Exchange for iron ore prices as a reference point, due to the large volume of trade on the exchange, Morgan said.

"As many iron ore buyers use the Dalian Commodity Exchange to hedge their risks, the exchange quickly received significant liquidity. When it first started trading, we and other people in the market were surprised by how quickly this liquidity came. Given its status now, it's hard for anyone else to try to wrest it away," he said.

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