London Metal Exchange Rings the Changes

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Metal Prices

Iakov Kalinin/Adobe Stock

The workings of the London Metal Exchange, however vital for the day-to-day pricing of the metals consumers buy, are often something of a mystery to the average industrial user.

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Not least, we have always felt, because the language used is the jargon of insiders, traders, brokers and dealers who transact tens, even hundreds, of millions of dollars of transactions in a day. They quietly — or not, if you have ever witnessed open cry trading – move the world’s metal markets in the process.

The accurate and efficient working of those markets is of vital importance to producers, traders and consumers of base and ferrous metals. If markets fail to operate efficiently, if volumes fall and liquidity wanes, the spread between buy and sell can increase, trades do not get promptly laid off and risk increases along with volatility.

We may not know it, we may not like it, but an efficient futures market is in the interest of every metals consumer — so when the new CEO of the LME Matt Chamberlain was officially confirmed in his role in April, one of the first steps was a grassroots review of the Exchange in consultation with users and industry.

To his credit, this was aimed as much at wider users of the Exchange’s services as it was those insiders active on the ring on a daily basis. The result of a long discussion process over several months has been 162 responses from the market, including, in the interest of full disclosure, from MetalMiner.

The result is probably of more interest than the process. But before we pick through the bones, the most encouraging message is the LME’s renewed commitment to physical trading, to the philosophy that has underpinned the exchange for 140 years — that any changes that are made in the way the exchange operates or the services it provides will be driven by the overriding principle that they should support, not harm the LME’s relevance to or ability to serve the physical market, explained Miriam Heywood, the LME’s head of media relations.

For a market that has seen the rise of the CME in the U.S. and the SHFE in China in recent years, it would have been understandable to make hasty attempts to mimic its competitors.

But the LME hasn’t done that, industrial users will likely be pleased to hear.

So despite the rise of desk and online trading, the LME will maintain the Open Outcry ring dealing system for setting prices, and will retain the daily settlement price (used globally to settle contracts and as a benchmark for pricing).

They will, however, add a tradable monthly implied price contract. While this isn’t a new contract, as such it will allow brokers to offer a monthly price visible on the electronic trading platform.

Shaking Things Up

In response to falling volumes, the exchange is making two significant changes.

The first is to reduce fees for certain kinds of transactions in an effort to promote the short- and medium-dated carry trades. Broadly, these are the lending or borrowing of lots over short time periods – up to 15 days for short trades and up to 35 days for medium trades. This used to be a hugely liquid and heavily traded market a few years ago, when aluminum and zinc warehouse stocks were at a much higher level than they are now and the cost to execute this type of trade was materially lower.

Fees for this type of trade were raised in 2015 and volumes have been in decline ever since, prompting this move to attract such trades back to the exchange by dropping fees to the level they were in 2012 before the LME was sold to the HKEX.

It should be said this move is not as altruistic as it sounds.

Liquidity is the life-blood of futures markets and even the LME could ill afford the loss of volume and revenue the decline in this short-dated market has experienced in recent years.

To help pay for this and to balance what is seen as a distortion between on-market trades and over-the-counter trades, fees are likely to be introduced from January for OTC trade.

Not that the changes are all about fees — a development we were particularly pleased to see is a lowering of barriers to entry for introducing brokers.

By formalizing the role of introducing brokers via an LME membership category, they will be able to access the LME’s systems directly and will facilitate access to clients. This is especially true in markets such as ferrous and precious metals, firms that could work with members to facilitate trades for smaller clients, yet use the security of the LME Clear system to guarantee counterparty risk.

We have long maintained that hedging services are as critical to a firm with a $10 million turnover as they are to a firm with a $10 billion turnover — but the former has been largely locked out of direct hedging services because of their small size.

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The development of a new breed of broker may allow such services to be available, finally.

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