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COLUMN-London Metal Exchange rolls back the years to move forwards: Andy Home
September 8, 2017 / 2:48 PM / 2 months ago

COLUMN-London Metal Exchange rolls back the years to move forwards: Andy Home

(The opinions expressed here are those of the author, a columnist for Reuters.)

By Andy Home

LONDON, Sept 8 (Reuters) - “The core mission of the London Metal Exchange (LME) is to provide pricing, risk management and terminal market services to the global physical metals industry”.

A statement of the obvious, maybe?

But, according to LME chief executive Matt Chamberlain, “we haven’t always said it enough”.

Chamberlain was speaking on Thursday as he presented the results of a market-wide discussion on what the exchange needs to do to arrest falling volumes.

He’s had 162 responses from LME members, physical market players, hedge funds and systematic traders and held follow-up meetings with many.

And everyone pretty much agrees on one thing.

Without the embedded interaction with industrial pricers, it’s not going to work.

GUIDING PRINCIPLE

So, the guiding principle of the “LME Strategic Pathway” is that “if any change would have the effect of weakening the exchange’s proposition to the physical market - then it will not be considered”.

That means a recommitment to the open-outcry ring and its role in setting the “official” daily prices used by industry players.

And it means keeping the current complex date system with those, mainly hedge funds, pushing for structural change having to settle for technical enhancements to the LMEselect electronic trading venue.

It also means lower fees, a complete roll-back of the fee hikes introduced after Hong Kong Exchanges and Clearing (HKEx) bought the LME for 1.388 billion pounds in 2012.

Or at least some of the fee hikes.

What the LME giveth, the LME can taketh. Specifically from those players capitalising on the exchange fee structure to keep their clients off-market.

That’s work in progress with a Jan. 1, 2018 target date. And there’s going to be a lot of work in progress. Because despite the apparent victory for LME traditionalists, it looks as if the exchange is preparing for a period of almost continuous change.

THE SECOND BATTLE OF TOM-NEXT

Fees for short-dated carries, anything out to two weeks, will be cut to below pre-sale levels, effective the start of next month. Ring trades will be discounted further.

This marks the end of the Second Battle of Tom-next.

The First Battle of Tom-next was lost by the pre-sale LME executive, which waged a bruising and ultimately unsuccessful campaign also to charge more on short-dated carries.

And “tom-next”, or “tomorrow-next day” to use the full name, is the shortest-dated carry of them all.

Even by the standards of the LME’s arcane prompt date system, it’s a curiosity, an overnight roll, or “carry”, to the cash date. It’s an archaic niche in which dealers still talk about “dirty cards”.

“Tom-next”, however, is hard-wired into industrial participants’ needs for average pricing and inventory management, making it a highly liquid spread.

Or it was until the LME raised fees on it.

Slumping “tom-next” volumes have been a key factor in the LME’s broader decline in activity over the last couple of years.

That’s the problem with “tom”. It can confuse even insiders if they’re not trading it every day.

The LME confessed in its April Discussion document that its analysis behind the 2015 fee hikes “did not fully reflect the specific features of the carry market.”

So defeat is conceded.

The LME has thrown in an extra peace token in the form of fee cuts for any “carry” further along the curve where both legs are within 35 days of each other, effective the start of November.

But now we’re going to be trading like it’s 2011, will the volumes come back?

Was it just the fee hikes that did for “tom-next”? Or were other structural drivers, such as falling exchange stocks, at work? And now trading behaviour has changed, will it change back again?

The members seem confident the volumes will return and the LME is giving them a year to prove themselves right.

That’s how long the “initial period” of the fee discounts runs.

GRAPPLING WITH SHADOWS

While parts of the market get their fee bonanza, it looks like others will be paying for the LME’s generosity.

The LME’s owner HKEx is not in the business of charity and its chief executive Charles Li, speaking at a Reuters Newsmaker event on Tuesday, said the aim was to achieve fee neutrality over time.

To attempt this balancing act the LME is looking at a new fee to reflect over-the-counter (OTC) transactions.

Not all of them. That would be impossible. The whole metals business is ultimately OTC.

Just those parts of it that have capitalised on the current perverse LME fee incentive to keep clients on an OTC (90 cents per trade) basis rather than on-market (270 cents per trade).

“This is not, in the opinion of the LME, fair” since the OTC client is “using the same core pricing and risk management services provided by the LME”, according to the exchange.

And many others will agree.

Further “engagement” with the market is promised but this seems the most likely route towards fee neutrality.

NO CHANGE, ALL CHANGE?

The LME message this week was one of “no change”, a recommitment to the exchange’s 140-year roots in the physical metals world.

But that doesn’t mean that a lot of change isn’t going to come out of this collective thought exercise.

Industrial users like the way the “official” prices are set on the ring. But they don’t care much about the “closing” prices set on the afternoon ring sessions. Funds, who do care, would largely prefer an electronic solution. The LME will test it out “for an exploratory period” next year.

A “small minority” of “unhelpful” algo traders will be targeted for “microstructure-led” measures such as tick size requirements.

These are the ones using a “jumping-in-front” order strategy, according to the LME. Not “front-running” as it is commonly referred to in market circles, because the LME “believes that this term is highly misleading and should be avoided”.

And there’s plenty more too. Potential changes to the order booking system, to the status of introducing brokers, to the clearing function and to the market in LME shares.

There are going to be lots of new contracts as well.

A hot-rolled steel contract to complement the steel rebar and scrap contracts.

Cash-settled aluminium premium contracts, directly challenging CME’s product suite. Cash-settled alumina, molybdenum and, possibly, cobalt contracts.

No lithium contract, though. Not yet. This year’s “hot” investment metal “remains nascent in terms of pricing benchmarks” and the LME will settle for being part of the future pricing “debate as the market grows and matures”.

Just one thing about all these proposed new contracts, though.

They’re all cash-settled monthly futures such as trade on the rest of the world’s commodity exchanges.

The historical core of the LME might remain the same but the future, it seems, will look a lot different.

Editing by Edmund Blair

Our Standards:The Thomson Reuters Trust Principles.
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