The London Metal Exchange’s industrial users are steadily declining and the exchange has now embarked on an overdue root-and-branch overhaul of its physical delivery function

By Andy Home
London

It’s been three years since Hong Kong Exchanges and Clearing (HKEx) bought the London Metal Exchange (LME) and there is a sense that the makeover of the venerable old lady of metals trading is finally starting to bear fruit.
The warehousing demons that have so exercised the new management team since the acquisition have been tamed, if not fully laid to rest. The infamous load-out queues that strained to the point of breaking point relations with the LME’s industrial users are steadily declining and the exchange is now embarked on an overdue root-and-branch overhaul of its physical delivery function.
The LME has extended its foot-print into the precious metals world with the successful takeover of the platinum and palladium “fixes”, although in this age of heightened regulatory sensitivity, no-one calls them that any more.
New steel contracts will be launched next month, a second attempt to carve out a slice of the fast-expanding ferrous trading space. And talking of second times around, the LME is once again cosying up to the Baltic Exchange, which spurned the advances of its metallic cousin a couple of years back.
The LME is even starting to return some of the $2.2bn HKEx splashed out on its acquisition, contributing a nearby doubling of net earnings to the bottom line in the first half of the year thanks to fee hikes and the new LME clearing house.
The exchange will have much to showcase next week, when the great and the good of the global metals business descend on London for LME Week.
But there remains a simmering tension at the heart of this east-west marriage with parts of the old LME establishment worried that the revamp risks eroding some of the unique characteristics that allowed the exchange to build its global franchise in the first place.
And that franchise, meanwhile, is no longer undisputed as others try to muscle into a space dominated by the LME for 138 years. The LME has always been a curious beast in the world of commodities trading, a living throw-back to its origins in the Jerusalem coffee-house in 19th century London.
The uniqueness boils down to two interconnected features, the ring, where traders still meet to engage in that archaic ritual of open outcry, and a labyrinthine prompt date structure that allows users to trade any day between cash and three months. Without the date structure, there would be no need for the ring. Without the ring, the date structure would wither and conceivably die. What’s exercising minds among the handful of brokers still trading on the ring is the LME’s drive to open up key parts of the date structure to electronic trading.
The exchange calls it “enhancing liquidity”. Ring traders fear it will cannibalise liquidity. Their liquidity. Because outright trading on the LME’s benchmark three-month date has already largely migrated to the screens but no-one has yet found a way to replicate the plethora of potential spread trades in the electronic world.
Emphasis on the word “yet” in that sentence because the LME is proposing to appoint electronic market-makers to trade specific dates and spreads in the cash-to-three-months prompt date maze. The trial programme will cover aluminium, copper and zinc, the LME’s three highest-volume contracts.
The problem for the old guard is the programme will cover the most liquid hubs of the nearby date structure, the first three third-Wednesdays, spreads between them and spreads between them and the rolling three-month date. Such is the bread and butter of ring traders and indeed of the ring itself. Amplifying the sense of insecurity is the continued contraction in the number of brokers trading in the ring.
The August departure of JPMorgan in favour of a second-tier category membership has reduced to nine the brokers who still form the spread-trading heart of the LME market. There is no finite figure for how many brokers it takes to form a liquid forum and there is no reason to believe that nine cannot do the work of 10.
But the trend of falling ring membership has been running a long time now and, despite the exchange’s commitment to retaining the magic circle of red leather chairs when it moves to its new Finsbury Square home next year, if the trend continues, the ring’s capacity to handle the weight of orders flowing through it will be increasingly challenged.
Without the ring and the date structure, the LME would start to look a lot like every other standardised commodity exchange.
And without either, users might start using other exchanges.

Andy Home is a columnist for Reuters. The opinions expressed are his own.