This article was written by Martin Hayes. All views and opinions are strictly his own.
LME close-out changes; open outcry strikes back?
Just before the Christmas holiday, the LME issued a notice about changing its daily PM kerb close-out schedules for copper and lead, an associated trial extension for zinc, as well as the possibility of a wider change to the complete procedure.
On a first glance, this mostly looks like routine tinkering with the current process better to facilitate trading patterns, business flows and the timely end-of-day matching requirements.
But – and here the law of unintended consequences could come into play – the comprehensive start-to-finish change to the whole close-out programme tantalisingly being floated if the zinc trial is encouraging could result in a rejuvenation of LME open-outcry trading.
Firstly, it is important to remember that the changes the LME is instituting from March 18, 2019 are because of proposals from its Ring Committee, which represents the traders and practitioners at the Exchange’s coal-face – the nine Category One RDMs (ring-dealing members).
Anybody who has watched the LME ring, its official pricing sessions just after midday, and, in particular, the PM close-out can appreciate the theatre and dramatic spectacle of open-outcry trading at its most acute – a USP that the Exchange has maintained, while nearly all other global financial markets have migrated to screens.
But - and this is not a criticism - it can during the most hectic and active sessions, notably the PM close-out, be severely challenging and less efficient to execute end-of-day orders and comply with regulatory requirements for matching and reporting. Currently, the phased close-out process sees large and small contracts alternate.
The time change between the PM copper and lead closes is not directly linked to how matching is performing – data since the current schedule was brought in in 2017 generally shows this has improved.
Rather, it will see copper have more ring trading minutes, align more with the CME copper contract and, in theory, allow more arbitrage opportunities between the UK and US markets, the idea being to increase ring trading volumes, not to mention business on Select and the telephone market.
Any potential new business could of course be equally spread across the three LME venues. However, computerised systems-based programmes in this day and age are likely to be quicker in identifying and executing arbitrage plays.
It will probably only be the nimblest and specialist operators who are able fully to grab any new arbitrage opportunities that are generated. So, the floor may only see marginal fresh volumes flows – welcome none-the-less for ring adherents.
Zinc on trial
The more interesting and potentially much more fruitful change that the LME is introducing is the zinc close-out extension period from five minutes to ten minutes, doubling the times of carry and three months trading from four and one minute to eight and two minutes respectively.
The intention is to allow more time for ring users to place orders, respond to price movements, alter with counter-orders and make execution of MOC (market-on-close) trades more efficient, while at the same time result in RDMs having fewer unwanted orders residing on their books.
This all makes sense, and it also doubles the time period where the three months close is arrived at to two minutes – this will make end-of-day price discovery more structured, by allowing all would-be participants more time to place their MOC business.
This is just an experiment, of course, lasting a minimum of three months, after which the LME will analyse the data and trends and if it is deemed to have worked and is an improvement, the other five traditional LME main metals – copper, aluminium, lead, zinc and tin – could have 10-minute close-out procedures brought in.
If so, this involves a root-and-branch overhaul of the whole PM trading time schedule, by ending the two separate sessions where each metal is traded individually – known as rings three and ring four, with unofficial prices based on the latter’s closing levels.
In many ways, the unofficial prices are an anachronism dating back to the last century – these prices have long been superseded in importance by the end-of-day closes and valuations needed for compliance and margining. So, there is no real necessity to have two PM sessions to arrive at staging-post unofficial prices.
Instead, ring-three and its unofficial prices will be followed by an extended close-out kerb running from 15:50 right through to 17:00 – a significant and possible game-changer for the open-outcry methodology.
Why? Well zinc has already seen increased order flows to the ring and the trial is designed to better accommodate that business – much of which is likely to be investment-based activity. Copper and aluminium are of course the main vehicles on the LME for investment business and index-orientated portfolio volumes.
A window of longer trading times for copper and aluminium may only see current volumes spread more widely. But, potentially, these extended times during this key part of the business day could foster more discretionary interest from financial players. In other words, fresh, extra business.
So, there may well be more liquidity, and as buyer-seller quotes, certainly towards the final seconds, are tighter and market depth usually larger on the floor, compared to the screen, this could beget even more liquidity and volumes - a shot in the arm for the ring next year, maybe?
What about nickel?
There is a sting in the tail, however, as at the same time as the close-out time changes and zinc trial, nickel will have its own long-planned experiment with VWAP electronic closing.
The law of unintended consequences also applies here, as if this is deemed a success once the data is scrutinised, the LME has the option of going down the road of electronic close-out procedures for all the main metals.
Consequently, there is plenty to play for next spring, and by the time summer 2019 rolls around, the LME may well be witnessing one of the most radical changes for many years to its trading modus operandi – only time will tell whether the ring or the screen will be the biggest beneficiary, and that will be down to its users and its membership to determine.