Metal market participants have largely expressed their support for the conclusions of the London Metal Exchange’s (LME) Discussion Paper on the future of its markets, although there are still concerns going forward. In January, the world’s oldest and biggest marketplace for industrial metals launched a consultation process on closing its open-outcry trading floor, aka the Ring, arguing that digital trading was the way of the future. Released June 8, the Discussion Paper aims to enhance the LME’s electronic offering, provide greater transparency, and preserve optionality for the exchange’s global customers. The LME incorporated most of the pressing suggestions ISRI’s Nonferrous Division submitted March 18, including physical market participants’ need for access to credit lines.
In its original Jan. 19 proposal, LME outlined changes in four main areas: Ring and reference prices; enhancing liquidity in the electronic market; potentially moving to a realized variation margin (RVM) methodology from the current discounted contingent variation margin (DCVM); and introducing policies and disclosures to strengthen market conduct.
“The LME has been floating a number of proposals over the years, including a shift away from Ring trading towards electronic trading,” says Joe Pickard, ISRI’s chief economist and director of commodities. Though the Nonferrous Division recognized the turn toward electronic trading, members raised concerns that some of the LME’s proposed changes could negatively impact those who work and trade in recycled metals and metals markets.
Receiving a record 192 responses to its Discussion Paper, the LME structured the outcomes to serve as a way forward that benefits the market and metals community as a whole.
“The Board believes that the pathway laid out fully respects the interests of the physical participants who sit at the heart of our ecosystem and achieves the right balance between fairness, choice, efficiency, and progression,” LME Chairman Gay Huey Evans says.
When reviewing comments, the LME observed that physical participants, including ISRI members, expressed a preference for prices to be determined in the Ring, given that group’s focus on the lunchtime official prices. There are several LME reference prices including closing, settlement, official, etc. “Traditionally, our members’ contracts have referenced the official prices, so they’re more comfortable with those,” Pickard says. In the outcomes, the LME respected their preference, noting that official prices would continue to be determined in the Ring, which reopens for trading Sept. 6, to support physical customers who use the prices on their contracts. To benefit the LME’s financial and larger physical users, closing prices will be determined electronically, enhancing participation and transparency.
While respondents overall supported the LME’s proposal to enhance electronic liquidity, many groups, including the Nonferrous Division, expressed some concerns. Specifically, ISRI members worried that simultaneously introducing electronic pricing alongside the proposed margin calculation changes could potentially impact market liquidity. In their comments, members noted the LME’s proposal to close the Ring and/or add too much liquidity and speed would hurt manufacturers, recycled metal dealers, and other market participants that deal in physical metals, because the pace of physical metal trading cannot match the pace of electronic trading. To address the concerns, the LME intends to introduce a set of solutions to enhance electronic liquidity, taking input from respondents, from 2022 onward.
The Nonferrous Division took issue with the LME’s proposal to move from the current contingent variation margin (CVM) to a realized variation margin (RVM). The CVM realizes forward profits until the settlement date; an RVM methodology pays profits on a trade date +1 basis. Under the CVM, “The expectation is that the timeframe for market participants’ physical contract period will match the expiration of the futures contract, which in turn helps to keep credit requirements in check,” Pickard explains. “Members were concerned changing the margin means people on the physical market, like scrap processors, would have a harder time accessing credit to continue trading on the LME.” He adds that the LME is raising fees for in-person trading, which will inhibit recyclers’ abilities to hedge their price risk.
Recognizing that its smaller physical participants favor CVM while its larger physical and financial clients favor RVM, the LME tried for an outcome that would benefit both groups. They decided to retain CVM in the medium term, while studying an approach that could recreate the cash flows of a CVM model for RVM contracts—supporting the traditional brokerage community in the provision of credit to its smaller physical clients. Pickard says the LME’s decision to keep CVM is a positive for ISRI members, but ISRI will monitor the situation to see how the LME investigates a new system after the “medium term.”