Watchdog gets complaint on base metal ETPs

LONDON Mon Nov 8, 2010 3:05pm GMT

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LONDON (Reuters) - Britain's financial services regulator said it has received a complaint over plans for base metal exchange traded products (ETPs), reflecting fears they could tip a finely balanced copper market into deficit and distort prices.

The complaint had not come from official quarters of the London Metal Exchange, an exchange spokesman told Reuters on Monday, adding that the exchange had no plans to block ETPs.

But the FSA will look into issues raised in the complaint, potentially stalling a rush of ETP offerings in recent weeks.

"There are concerns that it (ETPs) would not just have an effect on the price, but could cause shortages in some metals such as copper," BNP Paribas analyst Stephen Briggs said.

Planned ETFs were partially responsible for fuelling the latest rally in benchmark copper futures towards record highs of $8,940 (5,541 pounds) per tonne.

The FSA said it has to "look at issues that have been raised," a spokesman said.

"We are not a price regulator. Generally what we would look at is the potential for market abuse or distortion of price and consumer protection."

ETF Securities said in early October it will introduce physical ETPS for copper, aluminium, zinc, lead, tin, nickel and a basket of the six major base metals. It has no date, as yet, for the launch.

JPMorgan Commodity ETF Services registered to launch an ETP for copper in a filing with U.S. regulator the Securities and Exchange Commission late last month.

UC Rusal, the world's top aluminium producer has said it would consider supplying metal to a physically backed ETP.

But consumers such as international copper products maker Luvata have said ETPs could be a cause for unease because they could tie up material needed by the industrial sector.

Physical ETFs are not totally new. Basinvest, in Zurich has been running a physical metals ETP for some time. (here

Canada's ScotiaMocatta, a unit of Bank of Nova Scotia, in May withdrew the IPO prospectus for its Physical Copper Fund in part due to a cloudy demand outlook that scared off investors.

DRAINING STOCKS

ETPs are securities backed by holdings of physical metal and investors can trade them as if they were shares.

Traders said ETP purchases could suck down global copper inventories such as those on the London Metal Exchange (LME) that are already constrained by declining ore grades and demand that has steadily improved since the global economic crisis.

"People are saying they have or are going to complain to the LME and the FSA. The argument is that they will distort the market and tie up the stocks," a metals trader said.

"My reaction is; how could the market be any more distorted and non-related to the real world than it already is?," he said, referring to the growing levels of speculative investor involvement on the London Metal Exchange.

A senior metals industry source called "irrelevant" the fact that ETPs have been very popular in bullion, because gold is used to a much lesser extent by industry.

"Copper is already looking at a situation where supply is not going to keep pace with production...If these products need to be physically backed, they will make the shortfall even larger and distort prices," the trader said.

"They will lead to enormous volatility because if they go ahead, there will be an enormous overhang of metals that can be released back to the market," he added.

The global market for refined copper is expected to swing into a 400,000-tonne deficit for 2011 from a small surplus this year, according to the International Copper Study Group.

This is roughly the size of initial demand for a copper ETF, Deutsche Bank estimated, based on precious metals products that drew in around two percent of global demand.

Global copper usage is expected to total 18 to 19 million tonnes this year, so 2 percent of that equates to roughly 300,000 to 400,000 tonnes.

LENDING GUIDANCE

At the London Metal Exchange's annual dinner mid October, the exchange's chief executive, Martin Abbott, said that large physical base metals positions held by ETPs could be subject to the exchange's lending guidelines.

These guidelines, designed to preserve an orderly market, govern the cost at which metal must be lent or made available to other market players by holders of dominant positions.

But traders said that metal could be stored away from LME-bonded warehouses, and out of the exchange's jurisdiction.

"It's naive to think LME lending guidelines could keep things in check. They don't have to use LME warrants or warehouses, they can use the same grades and store the metal in warehouses that are not LME regulated," the senior metals source said.

(Reporting by Melanie Burton and Pratima Desai; editing by Anthony Barker)

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