Will the LME Listing of Swaps Products Help Metals Hedgers? – Part Two

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MetalMiner welcomes back guest contributor Spencer O. Johnson, who has worked at INTL-FCStone as the primary risk management associate for steel since December 2009. Johnson co-authored this post with his partner on LME swaps, Dr. Mo Ahmadzadeh, who has over 30 years of LME trading experience. (This post is continued from Part One.)

Average priced (aka Asian”) swaps have been transacted in the OTC markets for many years — originally embraced by bankers that were constrained by the Glass-Steagall Act from entering into any physically settled commodity contracts with their customers. As financial institutions expanded the use of swaps in their structured risk management offerings, the LME benefited from the growing volumes in the underlying commodities that these same institutions had to trade on their own account to hedge their swap exposure to clients.

The post-AIG/Lehmann world saw the parlaying of terms for Dodd-Frank between regulators and practitioners and until the MF Global fiasco, that discussion appeared to be tilting towards some new version of the status quo. Prior to MF Global’s bankruptcy, the LME had no real urgency to list these instruments on the exchange as the exchange’s members were already building a steady business off of trading these swaps over the counter without central clearing from the exchange.

So what is the relevance of listing a product that was otherwise already available off-exchange?

The answer is that a move to clear the swaps is significant because it provides greater transparency for hedgers. With swaps previously available only through over-the-counter transactions, an effective overview of the marketplace would be more difficult for the average business, especially one that is only beginning the risk management process, or is new to the unique quirks of the London Metal Exchange.

Indeed, transparency may prove a benefit to everyone — more effective price discovery is in the interest of those throughout the metals supply chain and the ability for more average metals businesses to access that transparency may prove a significant boon to their risk management program.

It is also of use to the futures industry as a whole. Transparent pricing may help restore confidence in an industry that is still grappling with the questions surrounding MF Global’s demise.

That renewed confidence may prove to be a more direct benefit to hedgers as well. Average priced swaps can be a critical tool for hedgers who are looking at developing a risk management system to negotiate the difficult obstacles in selling manufactured goods at a fixed price when the major metal inputs for those goods remain highly volatile.

–Spencer Johnson and Dr. Mo Ahmadzadeh

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