Metal bashing

Warehousing rules put LME's new owner on the spot

The new owner of the London Metal Exchange is in a bind. Hong Kong Exchanges and Clearing (HKEx) paid an eye-watering 58 times prior-year earnings when it bought the world's leading metals marketplace for $2.2 billion last year. Now its plan to reform price-distorting warehousing practices is proving divisive. Hopes for a China-led expansion in LME trading volumes could fall short if customers decide the exchange's prices no longer reflect reality.

Long queues at a handful of LME-approved warehouses appear to have contributed to distortions in the global market for aluminium and some other industrial metals. Competition from financial hoarders taking advantage of low interest rates has pushed up the premium over LME prices that users have to pay to get products for immediate delivery. The premiums create extra costs and uncertainty for buyers, even though aluminium prices have fallen since the financial crisis. To address the problem, the LME has proposed requiring warehouses with long wait times to release more metal than they take in each day.

Judging from the comments from buyers and sellers, the proposal has gone down like a lead balloon. Top aluminum producer Alcoa warned that rewriting warehouse rules might drive more metal outside the LME system, potentially making the exchange's prices a less reliable reflection of real-world conditions. It wants the LME to make better disclosures about who trades metal, and introduce new financial products to help buyers hedge premium risk. Taking more or less the opposite tack, a group of big aluminium users last week argued the LME proposal didn't do enough to discourage warehouse distortions.

The grumbling points to a problem for HKEx. The LME used to be owned by the market participants. Its shareholders were its customers - big banks, metal brokers, and industrial buyers and sellers. Now that LME is owned by HKEx, it's arguably more vulnerable to customer flight. Alcoa warned that if the proposed rule changes were enacted, LME users might start to wonder if it is the "correct forum" for price discovery in the metals market. The high price paid for LME gives HKEx a big incentive to resolve the wrangling. But the complaints so far suggest it will have to step delicately in its search for a solution.