Don't Look Back!

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

When future metals industry observers cast an eye on what took place in the 2020s, 2021 may well stand out as the year the LME family came to a fork in the road, and, although reluctantly in some instances, decisively opted to go forward in a comprehensively different direction.

Actually, the roadmap that the LME’s Market Structure proposals represent is not just a change in direction and signposts on the road; rather it is akin to moving from a C road to a full-blown motorway, autobahn or freeway.

The LME has naturally changed and adapted in the long course of its history – in some cases this change has been forced and hastened by major events. In most recent times the Tin Crisis of the 1980s saw the principals’ market model dispensed with, while the copper scandal of the 1990s resulted in much more relevant regulation and increased transparency.

More recently, 2000 saw partial de-mutualisation, which paved the way for the 2012 full sale to HKEX in 2012. Along the way since then, there have been modifications to warehousing, forays into new cash-settled contracts, steel and precious metals, while a shift to greater environmental responsibility in the whole chain is on the way too, along with the relevant metal contracts.

But now 2017’s Strategic Pathway has morphed into something much more radical and far-reaching, and it is not necessarily a result of the global coronavirus pandemic, albeit that may have contributed to the likely end of open-outcry trading. 

Where the Ring is concerned, the near 12-months months of electronic pricing and valuations have demonstrated that open-outcry trading is no longer essential for the market and wider industry. Screen-based pricing has worked, surprisingly better than expected in many instances. 

RDM numbers have been declining throughout the 2000s, and when push comes to shove, out of the nine category one members, perhaps three or four are totally wedded to the ring. For most of the others, closing the floor won’t come as an ideological heresy.

However, the end of open-outcry trading, which, after all only accounts for a fraction of the LME’s daily traded volumes, is just a small part of much wider changes, that are becoming increasingly needed for the LME to maintain its still pre-eminent position in global raw material exchanges.

That does not mean that everything has to change. The daily prompt date system, unique to the LME, provides flexibility to the industry, has extremely good liquidity and functions perfectly well on the electronic platform, enhancing transparency. 

For the most part, this type of business emanates from the physical side of the market, so while financial-sector investment involvement – vital in laying off risk – will always be needed, prompt date availability underlines the LME as very much an industry-based market-place, as opposed to other exchanges, where the speculative profile is higher.

Alterations to fees – higher for member-to-member inter-office business, lower if carried out electronically – will probably divert activity on screen over time, especially if the ETC (Enhanced Transparency Cross) pans out as is likely.

Margining changes, while logical, could take longer to enact, given the way credit line availability operates for members large and small – the LME envisages a three-to-five year timespan. But RVM (Realised Variation Margin), or daily marking to market, is the financial exchange global norm, so standardisation is perhaps inevitable, over time.

All the changes outlined so far have a thread running through them, which neatly segues into the part of the discussion paper called Market Conduct.

That thread is regulation and transparency – relevant in a financial world where the tectonic plates have shifted significantly in 2021. 

For example, who would have imagined a bunch of nerdy gamers taking on and beating(?) hedge funds in a battle over GameStop stock. A similar flash mob operation in silver saw the price rise from $25 per ounce to $30, then back to some $27 in three trading days. 

And how about nine former IPE oil traders operating out of their Essex homes, who are rumoured to have made over $600 million profit on one day when the April US WTI crude contract expired?

None of this is directly connected to the LME, other than in the likelihood that politicians and regulators will up the ante. 

Better to take pre-emptive measures now, and for the LME, there is a focus on the areas of warrant reporting visibility and the thorny issues of potential squeezes.

The exchange proposes potential RNS-type disclosure relating to warranting and de-warranting of physical metal. This makes sense.

It is a requirement for stock market listed companies to make profit-warnings if the outlook has changed markedly since previous advice, or there is some unanticipated development. And, something that is relevant for the LME, share dealings for some company officials are not permitted within a timespan ahead of quarterly, interim or full-year results announcements.

A type of moratorium surrounding warrant movement announcements may be the way forward to allay any regulatory concerns, and some metal firms already do this. Likewise, a hardening up of measures to avert potential squeezes – rules to restrict the ability of single parties to accumulate larger warrant holdings may also follow.

And some measures – outright position limits – could be introduced to tackle looming squeezes further down the forward curve, while OTC reporting is designed to usher in greater visibility.

A lot of what the LME is proposing, especially in the latter area, will not be totally popular or straightforward to implement. But, to paraphrase JFK, the LME, its members and the wider industry should grasp the nettle and choose to do this, not because it is easy, but because it is difficult.

The pandemic is changing lives, practices and society overall. And it should also change the LME. There is very little point in looking back now.

#LordCopper