November 1, 2017 / 3:53 PM / in a year

LMEWEEK-LME copper margin cuts aim to regain volumes from CME

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By Peter Hobson

LONDON, Nov 1 (Reuters) - The London Metal Exchange (LME) is aiming to lure back investors from the CME Group’s Comex exchange, which has seen a surge in copper volumes with the help of its low margin requirements.

The LME said its plan to use a new methodology could cut by a quarter its margin requirement, or the sum that cash investors must set aside to settle obligations in case of default.

The LME still accounts for most of the world’s metals trading, but copper futures volumes fell 4.1 percent last year while those on Comex rose almost 30 percent.

“LME margins are double the Comex margins,” said a metals broker in London. “That is a significant reason why some funds have been switching to Comex from the LME.”

The LME requires a margin of $12,525 per 25-tonne lot of copper compared to $6,945 for an equivalent weight on Comex.

The difference is largely because the LME calculates margins based on the assumption it needs two days to manage a default. The Comex calculation is based on a one-day management period.

The LME said its plan to switch from CME SPAN methodology to a value-at-risk, or VaR, model might not cut the margin on each lot of copper but would reduce the cost of surrounding trades.

That, in turn, could cut total margin payments for LME members by up to 25 percent, a spokeswoman for the exchange, owned by Hong Kong Exchanges & Clearing, told Reuters.

SPAN and VaR both calculate margin requirements by modelling the risk to traders’ positions from changes in market conditions, but VaR gives a more precise calculation across a portfolio of different positions.

This allows VaR to better account for carry trades, which link contracts maturing on different dates, the LME said.

This is important for the LME because, unlike Comex, which offers standardised monthly futures contracts, the LME’s complex rolling date structure means investors use carry trades to manage their positions.

“Less initial margin is going to free up liquidity, it supports lowering the cost burden for dealers in the market and that is very positive,” said the head of a brokerage in London.

The change from SPAN to VaR was part of a strategic plan to boost volumes announced by the LME in September.

To allow members time to adapt, the new model would be implemented over 18 months to two years, the LME said.

As it launches VaR, LME also plans to introduce the option of initial margin calculated using a one day default-management period, similar to Comex, to attract fund investors.

This would reduce the margin cost, appealing to funds, while still offering the two-day model preferred by traders of physical metal as it gives them access to credit from LME members.

LME brokers can offer credit under the two-day model because it allows them to pool clients’ exposure and post margin on their net position, freeing up cash to lend. Under a one-day margin model, each client’s position must be paid in full.

Some LME members had called for the exchange to further cut margin costs by allowing traders to net their exposure across different non-ferrous metals such as copper and aluminium.

The LME said this was unlikely because the price of different metals often moved in different directions, so positions in different metals might not net off against one another. (Reporting by Peter Hobson; Additional reporting by Pratima Desai; Editing by Edmund Blair)

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