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25 June 2014

Bravo, LME - Open Outcry Lives!

Some really good news has come out of the LME this week, following its review of Ring trading. I have to admit that I have been somewhat sceptical about the future of the Ring since the takeover by HKEx, but the statement put out now appears to give an unequivocal backing to the maintaining of it “for as long as the market needs it”. Such a definite comment is an encouraging sign that despite some fears - including my own - about the discontinuity of  management of the LME caused by the change in ownership, nevertheless it seems the overall philosophy remains intact. 

Functional and Fair

So why is it important that the Ring should remain at the heart of the Exchange’s price discovery mechanism? Frankly, there is one essential reason - it’s a process that works effectively and is - broadly - accepted as producing a fair outcome by the users of the market. And while I talk above of the ‘philosophy’ of the market, the truth is that actually the question is not a philosophical one of deep debate, it’s in fact a pragmatic one - does it work? This is a commercial function and what is required is an effective, transparent trading mechanism. The Ring undoubtedly exerts an emotional pull (particularly on older traders, many now no longer active), but the only meaningful test of it’s usefulness is whether or not the trade at any given moment is prepared to rely on it as resulting in a fair price. The LME have undertaken a review and quite correctly ignored the siren calls of moving to a (probably) cheaper alternative in favour of sticking with the proven status quo.

Improvements to Come

Well, not entirely the status quo; they have also alluded to the need to spend some money on a closer integration of Ring and electronic trading. That’s actually quite important, because - as users will undoubtedly confirm - there are times when the disconnect between the two currently can be apparent. The target is to ensure that the tail can’t wag the dog - in other words, that the integrity of the price (and this refers in particular to the settlement price and, to a slightly lesser extent, the five o’clock close, both of which have significance as references) is not compromised by the ability to influence one of the trading mechanisms unduly. That the LME recognise investment is necessary to achieve this can only be welcome.

In fact, the results of the survey - as far as they have been released - seem to highlight two particular reasons why users like the Ring. The first, the one I refer to above, is that it is perceived to be an effective and, importantly, transparent way of establishing a trusted reference price for traders globally. Secondly, and I suspect that the direct users (category one and two LME members) were particularly vocal on this one, it is seen as clearly a more user-friendly way of executing carry trades than the alternative Select. Given the importance of that part of the business not only to trade hedgers but also to broker profitability, it is encouraging that the LME have shown their support.

Implications for Other Markets?

So does this possibly have implications for open-outcry trading in other markets? Actually, I think it does. I wrote recently that the LME were in a sense sitting on the fence over the silver fix because they hadn’t committed to which of their different possible proposals they favoured as their replacement scheme for the end of August. The fact that they have now given this endorsement to open-outcry as their favoured price-discovery mechanism may give a boost to those less than totally convinced of the need to go electronic when the current pricing system disappears. We should nevertheless bear in mind that whereas the LME survey of users came down in favour of open outcry, the LBMA’s polling of bullion market operators produced a big majority on the side of an electronic auction as the basis for price setting; but it is striking that the transparency of open outcry trading is highlighted so strongly by those who are familiar users of it. This flies in the face of those who have long been supporters of largely anonymous electronic platforms, and is a welcome boost to the position of those who maintain that an environment where firm bids and offers are openly exchanged is in fact a healthy, rigorous and transparent method of price discovery. The bold move by the LME now would be to make a firm proposal for silver pricing based on open-outcry trading, and further, at the appropriate time, put forward a similar proposal for gold. 

I haven’t always necessarily been in agreement with the LME management, but in this instance I believe they should be congratulated for listening to the trade and supporting a robust and well-proven price discovery system.

Honourable Behaviour?

On a different subject, an acquaintance of mine recently brought to my attention an episode which, he suggested, may be symptomatic of changing times; I’m not sure if it is that, or rather just an example of something which has always been going on. The trader in question runs a specialised concentrate trading operation, having previously been part of a larger organisation. Recently, he expended a lot of time and energy finding a home for a particularly awkward and complex concentrate with two smelters on opposite sides of the world. The first deliveries went through - to both buyers - and then when my acquaintance was looking for repeat shipments, he found that both customers had - behind his back, as it were - gone directly to the concentrate producer and negotiated terms for direct trade. Now, we would probably all agree that that is not particularly honourable behaviour, but I wonder whether readers would consider it a relatively recent phenomenon, or whether in fact it is, and has been for a long time, an unfortunate reality that large corporations’ way of treating smaller traders with only limited muscle is less than ideal. I have every sympathy with the trader in question, and it would be nice to think the parties to the business had some remorse, but I wonder if in fact they simply behaved as they always do, and cut out the smaller operator just because they could?   

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