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01 April 2020

When will the Bell ring again?



This article was written by Martin Hayes. All views and opinions expressed are strictly his own.


The ring falls silent…..but for how long?

What do David King, Simon Heale, Martin Abbott, Garry Jones and Matt Chamberlain all have in common? 

They are, obviously, the list of London Metal Exchange Chief Executive Officers, dating back to the early 1990s. They, also, have maintained ring-based open-outcry floor trading in the face of screen-based electronic trading platforms for the whole of this century.

That’s up until now. On Friday March 20, at 17:00, the LME ring fell silent, with all its business from Monday March 23 taking place either on the inter-office telephone market, or on the Select electronic platform – including the Daily Official Prices and end-of-day closing valuations.

Of course, this closure has been enforced due to the measures that the UK government has imposed to combat the global coronavirus COVID-19 outbreak – social distancing and non-essential travel among them. And as well as the LME, Lloyds of London shut its underwriting floor last Thursday, and is carrying on insurance business online.  

It was perhaps inevitable that the LME would need to do this, given that earlier last week an employee of one of the nine ring-dealing members (RDMs) had tested positive for COVID-19. 

And make no mistake – this is a big move for the world’s largest and most successful metals market.

Open-outcry trading has been the hall-mark of LME trading since 1877, and has only been interrupted twice – briefly in 1914 for a few months at the outbreak of World War One, and then the more prolonged closure at the start of the Second World War in 1939, not re-opening until October 1952.

Since February 2001, when LME Select was introduced, electronic trading has become more and more pre-eminent. Estimates vary, but over the last decade, daily business transacted in the ring has fallen to between 5% and 10%. 

But because that volume – small as it is now - encompasses the Daily Official Prices between 12:20 and 13:10 and the 17:00 Close – the global metals industry and wider market references respectively - the LME has been able to resist pressures to move entirely to screens, as virtually all other global financial markets have had to do in the last 25 years.

However, these are extraordinary times, and over the coming days, weeks and months, the LME will adapt, and inevitably evolve, to a new way of arriving at price references, via the on-screen VWAP (volume-weighted-average-pricing) method.

This is not entirely a shot-in-the-dark, as last year the LME ran a three-month trial period in its nickel market, with the end-of-day closes arrived at electronically on Select – a test that no doubt provided a useful template and data for what is happening since the start of this week.

Prior to the nickel trial, the low interest plastics contracts traded and were priced entirely on Select from 2010 to 2011, when they were dropped. The VWAP process used back then, which could have been imposed for the full base metals suite in an emergency, is being implemented now, albeit for much greater 2020 business flows.

And those larger business flows will dictate how radically LME price referencing changes now. Already, there is an implied cash price being displayed on screen, but the less-common and lightly-traded carry trades will be a challenge. Meanwhile, there is the provision for the LME’s in-house Quotations Committee to adjudicate prices, if needed, to buttress the reliability and creditability of the settlements.

(As a historical footnote, the latter is actually not without precedent. In the 1980s, due to a bomb-scare causing the LME to evacuate its Plantation House premises, the Quotations Committee, then made up of three senior floor traders, discussed and arrived at the Official prices in a shoe shop across the road in Fenchurch Street).

Nevertheless, given current global pandemic uncertainty, and the extreme turbulence and volatility in the world’s financial market-places, this is not an ideal time for a radical and short-notice shift in LME pricing procedures. But undoubtedly, the market will cope with the coming changes – the question is for how long, and what happens when the crisis passes?

Will the metals industry and the wider financial players tilt and lobby towards permanent electronic pricing? And what about the current nine RDMS, whose numbers have dwindled from over 30 in the 1980s?

Maintaining a floor-trading operation is costly and labour-intensive – the longer the floor is shuttered, and at a time when global economies are heading towards severe recessions, the greater the likelihood that some firms may review their RDM status. The risk is that an exit or two could provoke an exodus.

Those, however, are questions for an unknown and totally unpredictable future. 

The irony is that, whereas for a generation floor-trading has been immune to the threat posed by tiny electronic impulses – algorithms on HFT systems – it may be an equally minuscule invisible virus that results in the curtain coming down permanently on the floor.

  

 

 

 

 

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