If a big player can simply walk away from a trade with impunity, doesn't that undermine the whole futures trading system?
Damned straight it does. The same rules that apply to COSCO and Air China for their fuel purchases apply to the Johnson Family Farm in Iowa when they are trying to get the best price for their wheat for delivery in November.
The commodities markets would collapse.
If large players start to ignore the rules, probably.
Are Chinese firms really prepared to buy commodities on a cash and carry basis only?
That's it, isn't it?
Unless I am completely out in left field here, I submit the following illustration;
The PSCOT Shipping Company of Shanghai uses Diesel. You as CFO know that your fuel needs for the first quarter of 2010 are going to amount to something on the order of 500,000 tonnes of fuel. Let's say diesel is currently selling for $1,500/tonne from your favorite distiller, Royal Dutch Shell out of Rotterdam. You think $1,500 is a fair price based on what has happened to fuel prices over the course of the last 24 months so you enter into a contract for delivery in early January of 2010 for a half million metric tonnes (about a full tanker load).
The refinery in Rotterdam has yet to receive the shipment of crude. They get it in mid November (Having paid on a contract signed in perhaps April) along with orders from other major customers and start refining your diesel as well as kerosene, gasoline and the other fuels they have on order as soon as they have the cat cracker available later that month. The shipping time is 28 days or so from Rotterdam to Shanghai. They load the tanker on the 2nd of December
Payment is due to RDS when the fuel hits your storage tanks in Shanghai, i.e. on delivery and it will be made via wire transfer from your bank in Shanghai or Hong Kong to their bank in Amsterdam.
What if the price of crude plummets between now and January.
What if the price of crude skyrockets in the same period?
What if the tanker is hijacked by Somalian Pirates as it passes through the Gulf of Aden?
What if the tanker runs aground as it passes through the
Strait of Malacca?
All of the above would affect the value of your fuel and the contract you entered into for its delivery and all of it is well within the realm of possibility. You would want to protect yourself from any and all of these possibilities. You could do so by hedging your contract by various means. If all goes well and you get your delivery on time and in good order, would the cost of say - buying an option on a delivery for a half million tonnes of fuel for delivery the second week of January instead of the first week be justified? Since you entered into such a contract in order to protect yourself from the possible adverse outcomes, should you be allowed to simply not pay or settle on them?
If there were no mechanism for you to lock in a price now for delivery later, your fuel purchases are subject to the daily price fluctuation of the market. If during the 28 day transit from Rotterdam to Shanghai the spot price of diesel spikes by $100.00/tonne, it could be financially devastating. If there were no way to have a contingency in place (an option) to replace that fuel should it get hijacked/lost at sea/run aground, you would be fucked.
The Chinese entities in question made contingency bets that they lost on and now don't want to pay.
That's fucked up, any way you look at it.