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16 September 2015

The Nervous(?) Nine



A while ago, I wrote a piece on this website talking about the legacy of  Metallgesellschaft Ltd and its evolution through various ownerships up to the - in my opinion - effective ending of that team and the business that it had supported since the foundation of the company and its dissipation into the amorphous mass of JP Morgan’s brokerage business. Since I wrote that, JP Morgan has taken a further step and announced its withdrawal from LME floor trading, on the basis that its clients by and large are happier to interact with the LME through electronic methods.

Thirty-plus to nine

That withdrawal now leaves just nine Ring-Trading members of the LME, down in a generation and a half from somewhere north of thirty in the early 1970s. Those pictures we’ve all seen - and in the case of the press used as a visual attention-grabber at the top of almost any article about the metals industry - are now no more than a historic record, rather like the solemn Victorian gentlemen standing in ranks like a school or college photograph that feature in all the old LME histories. 

Demand

I admit that I was amongst those who had expected HKEx to abandon Ring trading as soon as they decently could after their acquisition of the market. Instead, and to their credit, they made it clear a short while ago that the Ring would remain as part of the suite of trading opportunities offered by the LME as long as there was a demand for it. How, then, does one judge the point at which the demand insufficient to maintain it? I spoke to a good friend at a major mining house, which has long been an active client of MG Ltd/Enron/Sempra/RBS/JP Morgan. I asked him if the demise of that company was likely to make his group look for a Ring dealing replacement. The answer was unequivocally no, they had no particular preference for using a floor member over a Category 2 member. The creditworthiness of their counterparty was always the prime consideration, and the method of executing business far less so. Now that’s in fact a perfectly logical approach for a mining company, whose overall strategy is to sell forward when they find the price attractive and then buy back those forward sales against physical trades. What does the status of the broker matter, as long as the open positions are financially secure?

Price discovery

I understand that approach fully, but there is another consideration, which blurs the picture a bit. Actual LME trades are important to those participating in them - and vital for brokers’ profitability - but beyond that, for the industry as a whole, there is the issue of price discovery. The reference price generated by the LME in reality is far more significant to the non-ferrous industry than is the method of transacting actual trades. In other words, the industry as a whole depends upon the reference price being seen to be legitimate and at a level at which the market genuinely can clear. The LME has been such a enormous longstanding success because the integrity of its official price has been globally accepted.

Nervous?

The way that price is constructed, therefore, is of general concern, not just a matter of whether or not a bunch of young men and women sit and scream at each other across a hollow circle. Open outcry has satisfied the requirements put upon it for a very long time. However, personally, I would be concerned that a Ring with nine members is getting perilously close to being in a position where it would struggle to present an appearance of legitimacy. I would regret its passing, both because it's something I’ve always been involved with (which frankly is a weak, emotional reason) and also because it has stood the test of time to maintain its status; however, we have seen in the gold and pgm markets that apparently robust systems of price discovery have been deemed inadequate. So should the survivors be a nervous nine? Sadly, I suspect they should, because I can see that a Ring so diminished in size may become the next target of those who believe that anonymous electronics are the only guarantor of a level playing field. 

I hope the LME can continue to defend its (now) unique system, but I fear if the trend continues, it may well have a large empty space in its smart new headquarters, once it moves. 

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