By Andy Home
“In short, this is not a takeover; it is a marriage”. That’s how Charles Li, chief executive of Hong Kong Exchanges and Clearing (HKEx), described the $2.2bn purchase of the London Metal Exchange (LME) back in 2012.
He was speaking at the LME’s annual black-tie dinner at the Grosvenor House in London, conceding that it was the first time he himself, once an oil worker, had ever worn a black-tie.
The dinner forms the centre-piece of “LME Week”, described by Li as “a pilgrimage of like-minded people (...) where the financial meets the physical; where the best minds meet with the largest hands; where the money meets the rock.”
Two years on and Li will next week once again sit at the high table at Grosvenor House along with the new management team installed after the purchase.
He, and the massed ranks of the LME brokerage community seated around him, may well be minded of the witticism penned by Canadian playwright Raymond Hull. “All marriages are happy. It’s the living together afterward that causes all the trouble.”
It’s fair to say this marriage has not got off to the best of starts.
HKEx has found itself embroiled in the toxic legacy of the LME’s dysfunctional warehousing system, spending much money and time fighting off a flurry of lawsuits and multiple regulatory pressures.
The mood among the LME’s brokers is sombre as they face up to the reality of a new fee structure, which, according to Martin Pratt, chief operating office of Triland Metals, will “undoubtedly force metal market participants to carefully review their business models and trading relationships.”
It may, in other words, not be the most exuberant of LME Weeks as the largesse of the past gives way to a new-found austerity among the week’s many parties.
The exchange’s swoop on the platinum and palladium price “fixes”, however, could be a sign that things may be about to get better for both partners in this east-west marriage.
In truth, the LME “Street” knew from the very start that its previous low fee structure, predicated on the old member-ownership model, would have to change.
Indeed, it’s benefited from a two-year stand-still on fees that will end at the start of next year. It’s just unfortunate that the new fees are coming on top of the extra costs of being in the financial brokerage business caused by post-financial-crisis EMIR, or the European Market Infrastructure Regulation to give it its full name.
Hence the predictable wailing and gnashing of collective teeth and the nit-picking over the LME’s claim that average trade-weighted transaction costs will rise by 34%.
The LME’s fee structure is as labyrinthine as the market’s date structure, inextricably so. It’s true that some components of the transaction costs will increase by far more, 97% in the case of non-ring exchange trades.
But the real issue with the new commercialisation strategy, as HKEx calls it, is the legacy of the totally non-commercial ways of the past, such as brokers not charging customers for short-dated trades such as “tom-next”.
That will have to change and some of the public statements made since the new fees were announced late September may be more calculated at preparing clients for those changes than having a swipe at the exchange’s management.
HKEx itself may have more justified grounds for grievance with its new partner.
It probably underestimated just how toxic was the debate about the aluminium load-out queues at some LME warehouses. It almost certainly didn’t expect to spend quite as much time in law-courts, both in the US and the UK, as it has done over the last couple of years.
From a public relations perspective, it’s been an ordeal by fire and the spate of global headlines containing the words “LME”, “warehousing” and “manipulation” has pushed any idea of extending the LME’s warehousing network into mainland China firmly off the agenda. From a commercial perspective, the LME now also has a major new challenge to its franchise in the global aluminium market in the form of a rival contract from the CME Group.
Adding insult to injury was the legal attack by Russian aluminium producer on the LME’s proposed solution to the queue problem.
That action has now been seen off, albeit after 10 months of lawerly debate. That clears the way for the LME not only to introduce its new load-out rules but a potentially more far-reaching overhaul of its physical delivery function.
Skirmishing in the US courts continues, although here too the LME and HKEx will feel they are gradually turning the class-action tide.
The growth in LME trading volumes has slowed sharply this year to just 3.7% over January-September from 7.1% last year. Indeed, it looks set to be the third straight year of slower growth since the boom times of 2011.
That translates into less revenue growth for everyone; brokers, LME and HKEx.
This reflects market realities such as the lacklustre range-bound trading that has characterised the copper market for much of the year. It’s worth noting that CME copper volumes, for example, have also fallen this year and by a harder 19% than the 8% contraction in the LME’s flagship contract.
But breaking the LME volume figures down by contract reveals a problematic trend. Three of the four worst performers have been the LME’s most recently-launched contracts.
Steel billet has fallen into complete disuse, while volumes in the two minor metal contracts, cobalt and molybdenum, have dropped by 11% and 36% respectively and not exactly from a high base in the first place.
The LME portfolio of industrial metal contracts needs a refresh. And it’s not hard to see from where it might come.
Copper volumes on the Shanghai Futures Exchange have also succumbed to the global trend this year but the year-to-date contraction has been just 1%.
Aluminium volumes have quadrupled, zinc volumes have tripled and lead volumes over the July-September period were the highest in that contract’s history.
Iron ore trading is booming on both the Singapore Exchange and on the Dalian Exchange, both of which have benefited from pricing volatility in China’s largest metallic import market by volume.
The time appears right for HKEx to deliver on its promise to use the LME’s metals franchise as a way of leveraging its existing position as gateway through China’s Great Currency Wall.
It is preparing to do so via the relaunch of yuan-denominated “mini” contracts derived from the LME’s copper, aluminium and zinc contracts.
The LME, or as Li likes to call it, the western wing of the HKEx house, is also mulling new contracts.
And the most positive achievement over the last couple of years is getting to a place where it will be much easier to do so than in the past.
Andy Home is a columnist for Reuters. The opinions expressed are his own.