January 22, 2019 / 1:50 PM / 6 months ago

Column: London Metal Exchange to launch seven new contracts

LONDON (Reuters) - The London Metal Exchange (LME) has unveiled details of seven new contracts that will launch on March 11.

Traders work on the floor of the London Metal Exchange, in London, Britain September 27, 2018. REUTERS/Simon Dawson

This represents something of a revolution for the grand old dame of metal trading.

New products in the past have been few and far between and not many of them have been successful.

This has left the exchange dependent on its core base metal contracts for the bulk of its trading volumes.

Chargeable average daily volume, which is now the LME’s favoured metric, excluding as it does the UNA trades introduced to ensure compliance with MIFID II regulations, increased by 5 percent last year after three years of stagnation.

The LME will be hoping that the multiple new contracts will further boost trading activity.

The new contracts also represent a change of direction in that they are all cash-settled futures indexed against physical market price assessments.

There will be no physical delivery, which has stymied several new contracts in the past, and there will no weird and wonderful prompt date structure such as those on the core base metals portfolio.

These new contracts are similar in nature to those traded on the CME. In several cases, they will directly compete with the U.S. exchange’s metals suite.

ALUMINIUM PREMIUMS AND ALUMINA

There will be two new aluminium premium contracts, one indexed against Platts’ assessment of the Midwest U.S. market and one against Fastmarkets MB’s assessment of the duty-unpaid European market.

The CME has enjoyed first-mover status on aluminium premium contracts, having introduced the first of four, the U.S. Midwest premium, as far back as 2013.

That was the era of super-charged aluminium premiums, widely attributed to the long load-out queues in the LME’s storage system.

The LME did launch its own premium contracts, but the complexity of designing them around physical delivery meant that they were still-born.

Now the LME is going head to head with the CME but it does have the advantage of running the aluminum contract which underpins the physical premium market.

The new contracts, the LME says, are a response to “market requests from users who wish to manage their entire aluminium price exposure on a single venue.”

There may be more to come.

“The LME understands that the premium pricing market continues to evolve, and has committed to a user choice model whereby the LME will support the growth of the market by listing complementary aluminium premium indices, should market participants request this.”

A new alumina contract will also compete directly with the CME, which launched its own alumina contract in 2016. The CME contract has, however, enjoyed only limited success with volumes last year a marginal 5,755 contracts, down 14 percent on 2017. It didn’t trade at all in December.

Yet, there is a very real need for a liquid global alumina contract, as shown by the turmoil in this part of the aluminium production chain last year.

Having moved away from linking the price of alumina to that of aluminium, the industry found itself with no natural hedge against extreme volatility in the alumina price.

The LME’s contract will be priced using a basket methodology, using both CRU and Fastmarkets MB assessments, in an attempt to better reflect how the physical market operates.

STEEL

The LME will be introducing two new hot rolled coil (HRC) steel contracts, one indexed against Platts’ assessment of the North American market and one against Argus’ assessment of the Chinese export market.

The exchange is also still “working to deliver” a European HRC contract.

The LME has two existing steel contracts, one for scrap and one for rebar.

The scrap contract has been a stand-out in terms of its trading volumes, up 56 percent last year on a chargeable average daily basis.

Rebar hasn’t taken off in the same way. Volumes fell by 16 percent last year but the LME says there are tradeable prices 15 months down the forward curve on both contracts.

Total combined volumes since the contracts were launched in 2015 have been a respectable 10 million tonnes.

Although CME also has a steel scrap and a North American HRC contract, it is noticeable that outside of China, where the Shanghai Futures Exchange’s rebar contract trades over a billion contracts a year, the steel sector has been remarkably resistant to the concept of exchange trading.

This is all the more surprising given the explosion in iron ore trading in the wake of the collapse 10 years ago of the old “benchmark” pricing system.

The iron ore pricing revolution has until now largely failed to travel down the steel value chain, as producers are reluctant to lose their pricing power and fear futures trading will open the door to speculative price drivers.

The LME is evidently hoping to chip away at that collective reluctance to embrace futures pricing.

MINOR METALS

The other two new contracts will be for molybdenum and cobalt.

Molybdenum, indexed against Platts, will replace the existing contract, which hasn’t traded since June 2016.

It too was hobbled by the complexities of physical delivery with the size of LME warrant (10 tonnes) different from the size of lot (6 tonnes) due to the nature of roasted molybdenum concentrate.

The LME will keep its existing physically-settled cobalt contract because some parts of the cobalt industry are using it as a reference point.

However, cobalt contract volumes slid 9 percent last year amid periods of wide disconnect between LME pricing and the assessments of Fastmarkets MB, which will be the index provider for the new contract.

LITHIUM TO COME

A lithium contract will be launched in the fourth quarter of this year, as the LME seeks to capitalise on the electric vehicle revolution.

This is a hotly contested arena in terms of price provider.

The LME has narrowed the field to three: Fastmarkets, Benchmark Mineral Intelligence and Argus. The chosen partner will be announced “in the coming months”.

Lithium more than any other new product is a sign of just how far the LME has come in terms of its willingness to embrace the new.

Whether all the new products will be successful remains to be seen but the exchange has taken an important step in revamping an increasingly tired-looking product range.

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

Editing by Edmund Blair

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