NEW YORK (Reuters) - The CME Group is quietly carving out a growing share of the global copper futures market, eating into the London Metal Exchange’s near monopoly just as the UK bourse reviews offers for a potentially game-changing takeover.
Trading volume in the U.S. COMEX contract, often overlooked outside of North America, has surged 47 percent to record highs in the first four months of this year. Activity in the LME contract has climbed by just 11 percent from last year, according to a Reuters analysis of data from both exchanges.
The New York exchange took 13.5 percent of global copper futures trade measured by metric tons (1.1023 tons) between January and April, up from almost 12 percent last year and double its share from just three years ago. Total global trade includes the Shanghai Futures Exchange (SHFE), which is closed to many outside investors.
The LME’s share of global futures trade fell to 65 percent this year from just over 70 percent. Only once since 2005 has LME’s annual volume been below that level -- in 2009, as Shanghai trading surged. Five years ago the LME traded over 10 times as much copper as COMEX; in April, LME traded the equivalent of 81 million metric tons, only four times more than COMEX.
The CME says the pick-up in activity accentuates a trend underway for several years, pushing what has been a niche, regional contract toward a “tipping point” that could propel it onto the global stage.
But traders and analysts disagree as to whether the trend is a short-term blip or a lasting shift.
Some say it reflects greater arbitrage opportunities or the result of a short-term inversion in market structure. A few suggest it may be tied to the failure of MF Global, as the UK insolvency trustee struggles to return funds to the broker’s LME customers.
“I’ve been buying New York and selling London due to the differential. It’s been pretty decent volume and I wasn’t the only one,” said a New York trader at an LME Category II member.
Whatever the cause, the Chicago-based CME is in little danger of usurping the LME as the global copper benchmark.
But the swing comes amid one of the most dramatic periods of the exchange’s 135-year history, with Chief Executive Martin Abbott set to discuss at this week’s board meeting the two remaining bids by the InterContinental Exchange (ICE.N) or Hong Kong Exchanges and Clearing (0388.HK), estimated to be worth as much as 1.2 billion pounds ($1.9 billion).
Accelerating growth in COMEX could be a consolation prize for the CME, which had also bid for the LME but was cut from the running last week. But even if copper volumes doubled, they would be dwarfed by CME’s vastly larger energy, grain and financial contracts.
The stakes for the London bourse are much higher. Copper is the LME’s second most-active contract behind aluminum, accounting for about a quarter of its non-ferrous metal trade. Heightened global competition is pressuring management to boost profits and maintain market share, putting aside a century’s worth of keeping fees low for members rather than focusing on boosting its bottom line.
The New York market began gaining ground on its larger rival about four years ago as speculators -- including trend-following commodity trading advisors (CTAs), money managers, hedge funds and institutional investors -- emerged as a new breed of investor spying enormous growth as China’s economy took off.
After pacing the LME in 2007 and 2008, COMEX volumes have grown far faster in each of the past three years, one of the biggest growth spurts since the contract was launched in 1988.
The CME believes it’s a long-term trend, citing the popularity of its electronic Globex platform and increased commercial hedging.
“We’ve reached a tipping point with copper,” Harriet Hunnable, CME Group’s managing director for metals, said in an interview. “We’re seeing more Asian and European business and stronger business from the commercials.”
The LME declined to comment on the data.
The sudden surge in volume has surprised London traders, many of whom focus more on the SHFE, a valuable tool in arbitrage trade with the world’s biggest copper buyer.
“At the moment, I have more questions about the arbitrage between COMEX and the LME than the Shanghai and LME,” said one London-based analyst who declined to be identified.
The rise in New York volumes has also boosted COMEX open interest, an indicator of contract liquidity. It hit 2010 highs in February and has doubled since the start of 2008; the LME fell to multi-year lows last week, nearly flat over four years.
<^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^ Trade volume COMEX v LME: link.reuters.com/kev38s
Open interest COMEX v LME: link.reuters.com/rub48s
Some analysts say several abrupt surges in COMEX trade -- most apparent in February and April -- suggest it is tied to an “inversion” in the LME copper market that has rekindled an active arbitrage trade after years of dormancy.
In February, as global LME warehouse copper stocks deepened a months-long decline, the prompt LME cash price rose above the three-month benchmark, a structure called backwardation. That meant dealers rolling short positions by buying cash and selling forward were losing money each month.
On COMEX, however, inventories hovered near a more than one-year high, keeping prompt prices cheaper than future ones: a contango. Arbitraguers then fled London for New York, seeking both a cheaper price and the more advantageous market structure.
Average daily trading volume approached 80,000 lots in February, up from 50,000 from the year before, with February 9 and 12 topping 100,000 lots and setting new records.
“Those funds with a long/short strategy on the LME have got killed by the backwardation and moved onto Comex,” said a veteran New York-based copper broker. “We’ve heard of customers saying they’re not doing LME and are doing Comex only.”
The LME inverted again at the end of April, rocketing to as much as $155 per metric ton on a cash-to-three-month basis. While it has since eased to around $35 per metric ton, it is the longest stretch of backwardation since early 2011.
COMEX inventories then fell sharply in April and May, reaching their lowest since 2009 and shifting COMEX into a sustained backwardation for the first time in three years.
“There have been some arb games that helped COMEX volumes and some funny moves of LME to COMEX warehouses earlier this year,” said Citi analyst David Wilson.
The move is driven by funds and traders because unlike scrap merchants or copper fabricators hedging forward sales or purchases, they are punting on higher or lower prices.
Others suggest it may be fallout from MF Global’s collapse.
Within a few months of the broker’s bankruptcy, the U.S. trustee had returned 72 percent of customers’ collateral, with the CME offering $500 million of its own funds to speed refunds.
Under fierce pressure from its agricultural customers, the U.S. exchange also set a $100 million fund to be used to make customers whole if another broker went bust -- an unprecedented guarantee that none of the CME’s rivals have matched.
Redistributing lost funds from MF Global’s UK subsidiaries, which would include LME clients, has been slower due to a dispute over whether money was or should have been segregated under English law.
The UK trustee KPMG will return just 26 cents on the dollar for segregated accounts, but has also received 1,200 claims from non-segregated customers saying their funds should be treated as off-limits and part of the refund, a spokeswoman told Reuters.
“After MF Global, I think some funds opted to stay on U.S. soil because of the pickle with the payout and what was defined as client money,” said a trader at one of the LME’s dozen ring dealers, who are the most active participants in the market.
The latest data shows a stark reversal of fortunes for COMEX, which has long struggled to compete with the LME. Its aluminum contract was dropped in 2009 after ten years of failing to rival the LME’s larger, more popular product.
The two copper contracts are similar in terms of type and quality, but key differences account for some trade preferences.
COMEX’s monthly settlement, similar to other futures, suits funds seeking exposure to metal rather than hedging opportunities. Some commodity indices including the DJ-UBS index are also required to invest on COMEX; that contract has also gained market share from the once-dominant S&P-GSCI, which uses LME copper.
By contrast, the LME’s unique daily and weekly prompt date structure - based around the physical market and dating back to the 19th century - can be daunting to the uninitiated.
“The daily prompts are loved by the commercial guys, but most people don’t understand the (prompts) and the nuances of the LME that make it the gentleman’s market it is,” said a London trader with a Category II LME member.
While the LME does attract speculators, its traditional users are industrial, and these make up 30 of its more than 60 members. The LME’s unparalleled depth and liquidity, particularly in longer-dated contracts, make it popular with hedgers.
“Your problem with Comex is you can do something on the front month, but anything forward is a problem. Liquidity drops off like a lead balloon,” said the London trader.
Further competitive pressure looms in the east, where the SHFE is considered a greater long-term threat than its transatlantic rival.
But the biggest risk may rise from changes within the LME itself. Members including JP Morgan and Goldman Sachs will vote later this year on whether to sell their shares.
CEO Abbott may recommend one of the two bids at Thursday’s board meeting, with a vote as soon as the June 8 AGM.
No matter the outcome, the exchange now appears to be on an irrevocable course toward modernization, ending its long tenure as a not-for-profit with low fees meant to aid member-owners.
Even if it isn’t sold, management plans to hike transaction fees and build an in-house clearing operation in a bid to retain market share and boost profits, which are tiny compared with the 1 billion pound estimated price tag. Last year it made less than 8 million pounds profit.
“Everyone’s taking up the LME’s market share,” said the Category II trader. “The value (of an exchange) is volume coming through. For the LME, it’s always a worry.”
Reporting By Josephine Mason; Editing by Jonathan Leff and David Gregorio