Major Market Players Will Likely Kill LME Sale

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A recent Reuters article reinforces the popular image of the London Metal Exchange (LME) as an old boys club.

In spite of the LME’s pivotal role in setting metal prices around the world, the 130-year-old exchange is still privately owned, mostly by the large banks and brokerage houses that use it. At first blush, the potential price tag of some $1 billion for an organization that makes little profit would sound like a good deal, but the exchange’s low profit is the flip side of the low fees it charges its members, allowing them to amass substantial fortunes on the own books.

But Regulations Will Eat Into Our Profits!

But it isn’t fees the banks are concerned about as much as regulation. The largest shareholders – JP Morgan (now owners of MF Global’s 4.7% stake) and Goldman Sachs — between them own some 20 percent of the LME and both are heavily involved in the warehouse trade. An extremely lucrative business, particularly in a recession when stocks rise and need storage, and particularly when you set the rules that allow tens of thousands of tons to be delivered in a day but only hundreds of tons to be withdrawn, results in captive client. For a few major players, this has been a very successful business model, earning them substantial fees, access to privileged information on stock movements and allowing them to influence (if not actually manipulate) the market.

The banks fear a potential suitor like the CME Group or the Intercontinental Exchange could bring heavier US CFTC regulation and enforced transparency which the British FSA has not. The Federal Reserve and the European Commission are cracking down on risk-taking by large banks, and commodities are also coming under fire as regulators try to make the financial system more resilient to withstand future crises, Reuters says, while the CFTC voted in favor of position limits that will cap the number of futures and swaps contracts any single trader can hold.

Change on the Horizon?

Not all members of the LME agree that a sale is undesirable; however, some brokers say greater transparency would be a good thing, preventing banks from building large positions and influencing the market. Others point to the rise of electronic trading and say the LME needs to move with the times; consolidating with another exchange(s) would be the best way to preserve its long term viability. For some it will be a choice between a substantial short-term, lump-sum gain and longer lower transaction fees and lighter regulation — for a few like Goldman and JP Morgan, it will be their whole business model.

The general expectation is the banks will manage to muster the 25.1% ‘no’ vote required to scupper this deal, but that sooner or later, fundamental change is inevitable. Most firms relying on the LME for price fixing and hedging services would probably welcome an early transition to a more open, better regulated and less member-centric business model sooner rather than later.

–Stuart Burns

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