Column: Battle lines drawn for London Metal Exchange: Andy Home

Silver Acadia Exploration

08/10/2018 02:00

(Repeats Oct 5 column without change. The opinions expressed
here are those of the author, a columnist for Reuters)
    * London market faces growing competition from overseas
rivals
    * CME and ShFE becoming increasingly assertive in global
metals
    * LME trading volumes: https://tmsnrt.rs/2OxqOZZ

    By Andy Home
    LONDON, Oct 5 (Reuters) - The great and the good of the
global metals industry are descending on London, making their
annual pilgrimage to the London Metal Exchange's LME Week
jamboree.
    They do so because the 141-year-old market sets the world's
reference prices for everything from aluminium to zinc. And away
from the many seminars and cocktail parties, metal producers,
traders and users will meet behind closed doors to hammer out
details of next year's contracts. 
    For all that, the venerable institution has not been without
its detractors and it has had to quell the discontent of recent
years by pivoting back to its core industrial user base and
reversing fee increases instituted after the 2012 purchase by
Hong Kong Exchanges and Clearing (HKEx) 0388.HK . 
    The revamp is timely and the LME is now able to look to the
future with multiple new product launches planned for 2019,
countering its increasingly assertive rivals in the form of
North America's CME Group  CME.CD  and China's Shanghai Futures
Exchange (ShFE). 
    
    Graphic on LME Trading Volumes: https://tmsnrt.rs/2OxqOZZ
    
    VOLUMES UP, AT A PRICE
    The good news for the LME has been a recovery in trading
volumes after declines in 2015 and 2016 and anaemic growth of 
less than 1 percent in 2017. 
    Headline activity was up almost 10 percent in
January-August. But as ever with this curious institution and
its byzantine prompt-date system, the apparent surge comes with
some important caveats. 
    Strip out what the LME terms "UNA trades", a free way of
aligning some of the exchange's arcane practices with the
MiFID II regulations -- designed to harmonise financial services
across the EU -- and the growth was a slightly less stellar 8
percent. Or 4 percent after a weak year-on-year performance in
September. 
    New contracts such as gold and silver have helped. So, too,
have those fee reductions on spread trading introduced in the
fourth quarter of last year.
    Success, however, has come at a price. 
    HKEx reported a 2 percent decline in revenue and a 20
percent decline in operating profit from its commodities
business in the first half of 2018, largely because of lower fee
generation on the LME franchise.
    Having taken the short-term pain to assuage its members, the
LME is going to claw back revenue in other ways, such as a fee
on some over-the-counter contracts and a potential charge for
those currently free UNA trades. 
    And, of course, by expanding its portfolio to include gold
and silver options, three new steel contracts and five new
non-ferrous contracts. 
    The eagerly awaited lithium contract, a grab for the
electric vehicle space, is not on the initial list but is very
much a work in progress.
    
    WESTERN CHALLENGE
    Several of those new contracts -- hot-rolled coil steel,
aluminium premiums for both the U.S. and European regions and
alumina -- will set the LME on a collision course with CME. 
    The CME exchange rolled out four regional aluminium premium
contracts over 2013-2016, capitalising on industry unhappiness
with the disconnect between the LME's primary aluminium contract
and surging physical market indicators, widely attributed to the
LME's own warehousing issues. 
    The LME responded with its own physically-settled contracts,
but none traded -- if you ignore the eight lots mistakenly
registered by one fat-fingered trader in April 2017.
    All the LME's new contracts will use the standard vanilla
CME futures model. There will be no physical delivery, no
multiple prompt dates, but rather monthly futures cash settled
against industry benchmarks. 
    The CME has first-mover advantage, but the LME is the
generator of the underlying aluminium price, making it a logical
one-stop market for those wanting to trade both components of
the "all-in" price. 
    Aluminium and steel are new fronts in an evolving
competition between the two exchanges. The main battle ground is
currently copper.
    Long a distant poor cousin to the LME's flagship contract,
the CME copper contract has grown exponentially in recent years.
Volumes grew by 27 percent in 2016, 26 percent in 2017 and are
up another 35 percent this year. 
    Even more spectacular has been the rise in CME copper
options activity. Average daily volume this year has mushroomed
by nearly 340 percent and open interest by 175 percent, the
exchange said last month.  urn:newsml:reuters.com:*:nPn8bYrf9a
    True, volumes have been boosted by the CME's market-maker
programme, a stimulus that doesn't exist on the LME. 
    But with the CME claiming that more than 20 percent of its
copper options business is now originating outside of the United
States, it is clear it has been gaining market share at the
expense of London, where copper volumes slid 8 percent last year
and have flatlined so far this year. 
    
    EASTERN PROMISE
    The ShFE has just launched its own copper options contract,
only the third such commodity derivatives offering in China
after sugar and soymeal.
    Like many Chinese markets, the ShFE has a reputation for
sometimes wild fluctuations in activity, depending on what the
country's mass retail investment crowd considers the hot market
at the time. 
    The options offering, however, appears to be targeted at the
industrial and institutional players who currently trade the
international market. Volumes and open interest after the first
month of trading were 21,028 lots and 19,584 lots respectively.
 urn:newsml:reuters.com:*:nL3N1W624X
    Now, as the LME has consistently argued, there is no
pre-defined limit on how much copper can trade across the
world's exchanges, particularly given the different user
profiles. 
    If ShFE is successful, it does not automatically mean a hit
on the LME. It could, indeed, boost both LME and CME volumes by
lifting arbitrage. 
    Nor has it stopped more Chinese players from joining the
London market; witness broker Nanhua Futures' move to become a
member of the LME.  urn:newsml:reuters.com:*:nL8N1W54VP
    But ShFE's ambitions to translate China's dominance of
physical metal supply chains into trading clout are clear from
what it has not done. 
    It has, via Chinese regulators, denied the LME permission to
open warehouses in mainland China and has conspicuously declined
to "connect" with HKEx in the way Chinese stock markets have. 
    There is much eastern promise for the LME, but it comes with
a veiled threat.  
    

    <^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^
Chart on LME trading volumes    https://tmsnrt.rs/2OxqOZZ
    ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^>
 (Editing by David Goodman)
 ((andy.home@thomsonreuters.com, 44-207-542-4412 and on Twitter
https://twitter.com/AndyHomeMetals))