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08 June 2016

21st Century Metal Exchange

If you were designing from scratch a mechanism for trading metal forwards or futures to give producers, consumers and traders the opportunity to hedge their physical deals and speculators and investors the chance to bet on the price direction, what would it look like? Back in the nineteenth century, Rudolf Wolff, Charles Davis, Henry Bath and their peers knew the answer to that question. It was a ring of seats in an open hall where they could meet and transact business. They knew there would have to be a standardised contract (covering quality, delivery terms and so on) and a network of delivery points where title-holders could take delivery of their metal, if they so wished.  That’s how it had to be in that era; the available technology was limited, and face-to-face trading was effectively the only way business of that type could be done. Over the course of the next century and a bit, the technology advanced - wireless, telephone, teleprinter, telex; all played an increasing role in facilitating trades. But the central market place and face-to-face nature of the market remained, still representing an effective model for the business to follow.


On to that nineteenth-century model has now been bolted the product of twenty-first century technological advance, in the shape of an electronic trading platform. Now, to the best of my knowledge, Select is these days taking the lion’s share of the business transacted, which implies that users are comfortable with an electronic, impersonal system. Which brings us back to my opening question; if you were designing it now, how would it look? Communication - and the security of communication - is such now that the need for a ring of seats facing each other is probably no longer there. Why occupy a lot of space in one of the most expensive property locations in the world, when what you actually need is a bank of servers in a controlled-environment warehouse, anywhere, really? At the moment, the LME is operating as a kind of half-way house. It retains the old style and at the same time uses the new, so that we have the hybrid Ring/telephone/electronic trading forum. That’s because it has grown organically, modified as the available technology changed. Lots of things grow like that, and by and large survive perfectly happily, as the LME has. However, there is always the risk that something else will come along and, unburdened by the baggage of the past, leapfrog the existing model. 

Backwards or Forwards?

Over the last five years or so, I have had many conversations with a variety of people - like me, mostly from the older generation of LME traders - who have mooted the idea of a ‘new’ LME, one that goes back to old principles and strengthens the traditional style of the business. If you’ve grown up with the market as it is and invested many years of your career in it, then, frankly, it’s an attractive prospect. Who wouldn’t want to relax in the comfort zone that they have known for years? 

I think there is a potential threat to the LME, but I don’t actually think it comes from a return to traditional styles and values. Looking backwards is not going to be the way forwards. The danger is far more likely sitting in the minds of those looking at my opening question and coming up with a twenty-first century answer. That would, I suggest, be a market ‘located’ in the aforementioned warehouse, operating in cyberspace and circumventing most of the costs, because one thing that is consistently said of the LME is that it is a relatively expensive exchange to use. So, we have the SHFE looking at the prospect of setting up an electronic trading services dealer (in Hong Kong or Singapore) to enable its users to trade its contracts internationally; we have CME pushing its lower-cost metal contracts. And now we apparently have a trader group in London looking at the possibility of establishing a new market for trading metals. Suddenly, the LME, with its plush headquarters, and century and more of tradition, looks as though it could be overtaken despite the money and effort it has put into technological development. In fact, to continue with the analogy I used last week, perhaps the LME is still fighting the conventional war of Verdun, the Somme and Passchendaele while the swifter, unencumbered guerrillas of Lawrence’s irregulars are destroying the Ottoman Empire from within. 

Mick Jagger

Or perhaps I should just stop trying to see this through the prism of hundred year old history and simply quote Mick Jagger: ‘You can’t always get what you want, but……you get what you need.” And right now, the world seems to be starting to think it needs simpler, cheaper metal trading; and, importantly, the tools are there to make it a possibility.

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