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27 September 2017

The LME Welcomes I/Bs

Years ago, when the horse and cart was the principal means of land transport and shipping metal concentrate from halfway around the world to the hungry smelters of a rapidly industrialising Europe was a three month adventure, a bunch of metal traders decided that a means of protecting themselves from the unpredictability of prices for their products would be a fine thing. So they formalised their trading arrangements with each other and founded the London Metal Exchange. Note the use of the word “traders”; those early LME members were indeed traders, and their intention, through the mechanism of the market they established, was to mitigate their own trading risk. Now, over time, that simple purpose shifted and developed, as metal producers, consumers and speculators saw the advantage of the formalised forward trading market. Of necessity, since only members were able to trade at the innermost level, those members - the traders - began to morph into the hybrid broker/traders that have dominated the Exchange for a long time. The broker element, obviously, involves making trades on behalf of a different entity and benefitting through the commission earned on the deal. Different houses would be at different places on the spectrum, from pure broker at one end to pure trader at the other, often dependant upon ownership.

Recent times have seen an increase in the number of Introducing Brokers in the business, which I think as much as anything is a by-product of the combination of changing technology and changing regulation. Thus, as the large players, with regulatory requirements complicating the mix of house and client business and their shift to system-driven trading platforms, have found less use for experienced, customer-focussed brokerage personnel, those later have voted with their feet and set themselves up as I/Bs, to use their experience and contacts. All perfectly reasonable; I was always a supporter of using I/Bs, since that model gives a better control of overhead, and requires success before payment - a kind of version of no-win, no-fee, I suppose.

Anyway, where we are now is in a world where I/Bs are getting more numerous, and probably more effective; whether that lasts as a younger generation, more at home with electronic trading than with direct customer contact becomes more influential, is of course an open question. I’m really not sure.

The LME, though, seem optimistic. One of the new intentions they are putting forward is another membership category, this time for I/Bs. I’m assuming it will be a less expensive category than one or two, because it will obviously be much more restrictive than those. The idea - as with all LME innovation - is to increase volume, which I guess is a fair expectation; the wider the word is spread, the more business it will suck in - probably. But that in itself does potentially pose a problem. I’m sure I’m not unique in having seen how the words “LME Member” (or something similar) on a business card, letterhead or whatever, bestows a degree of respect, even reverence…… Now, those I/Bs I’ve referred to above undoubtedly understand the implications of this - after all, they have years of background. But the potential danger the LME will need to be aware of is the unscrupulous misuse of its good name. The further from the hub, the more difficult it is to regulate and oversee adequately. I/Bs are one of those steps further away, so although I would welcome this initiative broadly, I do think it will be necessary to watch very carefully the members in this putative new category. Almost by definition, their requirements, particularly capital requirements, will be less onerous than those imposed on category one and two members. 

Somebody will have to be sure they are listening if (and when) the alarm bells sound. 

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