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COLUMN-No relief for the London Metal Exchange as volumes fall again: Andy Home
April 12, 2017 / 11:50 AM / 5 months ago

COLUMN-No relief for the London Metal Exchange as volumes fall again: Andy Home

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

* LME volumes in Q1 by major contract tmsnrt.rs/2p4ZSDT

By Andy Home

LONDON, April 12 (Reuters) - The London Metal Exchange (LME) has just laid to rest its steel billet contract.

No need to panic if you didn’t notice. The contract hasn’t traded since June 2015. The last 65 tonnes of registered billet stock left the LME warehouse system a year ago.

The exchange has tweaked and prodded the contract many times since its launch in 2008 but to no avail.

“The LME believes that the steel billet contract no longer functions as an effective price discovery tool and risk management solution for the physical industry,” the exchange said in an April 10 notice to members. The contract will be suspended with immediate effect.

Fortunately for the LME, it has two replacement products for the steel industry’s hedging needs.

Its steel scrap contract, launched in November 2015, seems to be doing just fine. Volumes surged to 54,700 lots in the first quarter of 2017 from 1,729 a year ago. Open interest at the end of March hit a new record at 4,691 lots.

The steel rebar contract, launched at the same time, is also experiencing steady growth, albeit not on the same scale.

Unlike billet, which ran into deliverability problems almost as soon as it was launched, these steel products are not physically deliverable but are rather monthly contracts cash settled against third-party indices.

Such a format, the LME said, is “better suited for the risk management needs of the steel industry”.

The steel contracts’ success would appear to reinforce the case for the LME to re-engineer its other contracts towards a more standardised format.

Because the broader picture is one of still-falling volumes, keeping the pressure on the exchange, and its owner, Hong Kong Exchanges and Clearing, to try and turn the trend.

Graphic on LME volumes in Q1 2017 by major contract:

tmsnrt.rs/2p4ZSDT

STILL SLIDING

Average daily volumes on the LME fell by 13.1 percent in March and 4.6 percent in the first quarter.

Those headline figures, however, somewhat overstate the trend due to the higher number of trading days this year relative to last year.

In absolute terms volumes were down by “only” 1.5 percent in the first three months of 2017.

The problem is that the trend of falling volumes has been running almost continuously for over two years now.

Successes such as the steel contracts and cobalt, which has seen volumes explode over recent months as the price has gone on a super-charged rally, are still too small to compensate for lower activity in the LME’s core contracts.

True, there are other exceptions to the trend.

Both nickel and zinc saw volumes increase year-on-year in the first quarter to the tune of 5.0 percent and 6.8 percent respectively.

But on the other side of the ledger, aluminium alloy seems to be hovering on the brink of meltdown with volumes collapsing by 56 percent in the first quarter.

CORE PROBLEMS

Let’s face it. The alloy contract could go the way of other failed LME offerings such as molybdenum without creating any shock waves through the industrial metals landscape.

The real issue facing the LME, both exchange and trading community, is the slide in volumes in flagship contracts such as aluminium and copper.

The latter has become the poster child for the reformist faction in the LME community because of the contrast between falling activity in London, where volumes tumbled another 7.7 percent in the first quarter, and the CME’s contract, which saw volumes increase by 25.2 percent.

This seems to suggest that business is migrating away from the LME with its complex date system to the more vanilla futures product offered by CME.

But it may not be as straightforward as that.

If there was a wholesale shift of business towards CME because of its product structure, how come its lead and zinc contracts are moribund? Neither traded at all in March and lead hasn’t traded so far this year.

The CME’s most successful new contracts have been its physical aluminium premium suite, which complements rather than directly challenges the LME’s own aluminium contract.

That the CME copper contract is attracting incremental new business is not in doubt. To what extent it is doing so by directly grabbing existing LME business, on the other hand, is moot.

It’s worth noting, by the way, that the third pillar of global copper trading, the Shanghai Futures Exchange, has experienced a 41-percent decline in copper volumes so far this year.

Does that mean it too is losing business to CME or is it simply a case of speculative money moving into more exciting markets such as lead, where Shanghai volumes rocketed by 500 percent in the first quarter?

A FINE LINE

Excepting the puzzling copper piece of the liquidity jigsaw, the overall downtrend in LME volumes would appear to bear out the views of the traditionalists on the exchange, who argue that the real culprit is the increase in trading fees which has sent business back into the over-the-counter shadows.

How else to explain, for example, falling volumes in the lead contract with no apparent beneficial impact on the CME’s contract?

If fees are the real problem, traditionalists argue, there’s no need for a wholesale restructuring of existing contracts to stop the rot.

The demise of the billet contract may signify nothing more than that it was always a flawed concept, rooted in physical delivery in Turkey, a country that simply didn’t have the right tax code to cover trading of metal in bonded warehouses.

That the downtrend in LME volumes is a problem for the exchange and its users, particularly the broker community, is not in question.

Why volumes have been falling is a much harder question to answer. It’s a messy mix of industrial cycle, investment cycle, fee cycle and, somewhere in there, contract structure.

Pity the new chief executive who will have to disentangle this knot and try and find the fine line between traditionalists and reformists and their respective camps of industrial and speculative users.

Fortunately for him, or her, everyone is going to get a stab at answering the question. A major discussion paper is on its way.

Whether it generates a clear answer remains to be seen. But each passing month of lower volumes sharpens the question.

Editing by Susan Thomas

Our Standards:The Thomson Reuters Trust Principles.
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