(Repeats Feb. 23 column. The opinions expressed here are those
of the author, a columnist for Reuters.)
By Andy Home
LONDON Feb 23 It's time to talk about the
London Metal Exchange (LME).
The venerable old institution that sets the global reference
price for metals such as aluminium and copper seems to be
lurching from crisis to crisis.
Volumes are down. They fell 4 percent in 2015 and another 8
percent last year, the first time since the turn of the century
activity has contracted over two consecutive years.
Discontent is up, particularly among the core broker
community, which has bridled at higher trading fees and
lambasted the exchange's wooing of financial players.
The LME's chief operating officer Stuart Sloan left in
December. One month later came the resignation of its chief
executive officer Garry Jones.
To lose one senior office is unfortunate, to lose two in
such quick succession suggests deeper tensions with the LME's
owner Hong Kong Exchanges and Clearing (HKEx), which
has been trying to monetize its massive $2.2 billion investment
in the London exchange.
Rivals are lurking in the wings.
CME Group, which has historically only competed with
the LME in the copper space, has been rolling out new contracts
for other metals at an accelerating rate. Somewhere under the
radar is a potential new metals trading platform project led by
Jones' predecessor Martin Abbott.
More pressing is the drift of trading liquidity into the
Is the LME broken? And if it is, how is it going to be
Jones' departure has been the trigger for a bout of
collective soul-searching among the LME's members as they
attempt to answer those two key questions.
At the heart of the debate is the Gordian knot of fee
structure, date structure and trading structure.
The LME is a very strange institution. Electronic trading
co-exists with both a telephone market and open outcry in the
form of the talismanic leather-seated "ring".
It trades daily prompts out to three months, weekly prompts
between three months and six months and then monthly prompts
thereafter, the whole system rotating around a continuously
moving three-month "anchor" prompt.
Excepting the new steel contracts, it is not cash settled,
which injects a credit dimension to an already complex
Let's face. If you started from scratch, you'd never come up
with such a labyrinthine format. But that's the point. The LME
was never consciously designed. Rather, it has organically
evolved over a century of trading practice.
That rolling three-month date, for example, harks back to
the sailing times of copper-laden vessels from Chile to London
at the turn of the 19th century.
Which seems as anachronistic as dealers sitting around a
ring shouting at each other just as they did a century ago.
But this weirdly wonderful market structure has not only
worked but has proved remarkably resilient over time.
CUTTING THE GORDIAN KNOT
The genesis of this crisis was the hike in trading fees at
the start of 2015.
In particular the hike of fees on short-dated spreads, first
and foremost "tom-next", which denotes the spread between
tomorrow and the day after.
The cost of trading "tom" had in the past been so negligible
it was in effect a free trade for players rolling daily their
inventory price risk.
When that stopped being the case, volumes nosedived. Total
volumes in aluminium, the LME's most liquid contract, fell by 9
percent in 2015 and by 10 percent last year, but aluminium
"tom-next" volumes plunged by 24 and 23 percent respectively.
While industrial users voted with their feet, the LME tried
to compensate for the loss of volume by opening its membership
to new "liquidity providers" such as Chicago high frequency
trader Jump Trading, deepening the rift between industrial and
financial parts of the LME trading community.
The LME subsequently relented on those short-dated carry
fees but for many it was a case of too little too late.
And the debate has since moved on to encompass other parts
of the LME's unique structure such as that rolling three-month
Because unless a user trades in and out of the three-month
date on the same day, it becomes a multi-leg trade with higher
fees since the position has to be adjusted one day forward to
catch that Chilean shipping time.
Reformists, many of them sitting in the financial camp, are
suggesting an evolution to something a bit more, well,
conventional, simplifying both trading and fee structure.
Traditionalists counter that the uniqueness of the date
system is the "sine qua non" not just of the open outcry "ring"
but of the whole market. Start pulling at the strings of the
Gordian knot, they argue, and the whole thing will unravel.
Triangulating the debate is HKEx itself, which still needs
to claw back some of that whopping 2012 purchase price but which
has signally failed to deliver any tangible "China" dividend in
Squaring this problematic triangle will be the task of the
new chief executive. Or, quite possibly, Matt Chamberlain,
current acting chief executive and, on the LME "Street" at
least, favourite to take the helm full time.
And the irony is he might not have to look very far to find
a solution that could work for both sides of the change-don't
Although not trading yet, the LME's new gold and silver
contracts offer an interesting template for marrying the old and
They comprise a hybrid model of daily prompt dates over the
front part of the curve together with more standard monthly
future dates further along the curve.
That means industrial players can still roll their positions
daily using "tom-next", while fund players get the sort of
monthly roll trades they use in other markets.
Those precious contracts are only due to go live in June but
their structure has been designed to attract what is at the
moment an OTC market, similar to that which feeds the LME's base
And there is also a template as to how to go about cutting
Gordian knots on the LME. Chamberlain oversaw the reform of the
exchange's dysfunctional warehousing system, a similarly complex
series of intertwined problems that split the LME community.
A key part of the process was the extensive series of
consultations with stake-holders at every stage of the tortuous
Right now this debate about the increasingly dysfunctional
London dame of metal trading is taking place behind closed
doors. It needs to be opened up and formalised.
It's time for everyone to start talking about the future of
the London Metal Exchange.
(Editing by Susan Thomas)