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22 January 2020

Look Back - but not (necessarily) in Anger



This article was written by Martin Hayes. All views and opinions expressed are strictly his own.


Generally, as time passes, decades do not start and finish with neat symmetry. The 1960s, for example, did not really begin until January 1963, when the Please Please Me album was released by the Beatles.

However, sometimes the shift is more clear-cut – the 1980s began with a newly-elected UK Prime Minister Margaret Thatcher and US President Ronald Reagan heralding a social and economic sea-change from the previous decade.

For the LME the decade just ended – the ‘twenty-teens’ – did have a discernible beginning and end. In February 2010, the LME’s Chairman, Donald Brydon decided to stand down and was replaced in April by Sir Brian Bender. In 2019, Bender himself retired and has just been succeeded by Gay Huey Evans.

The handover sees a markedly-different Exchange going into the 2020s – and more changes to come. However, to assess what could happen next, it is instructive to recall what went before.

At the end of 2009, the LME was still trying to shake off the consequences of the 2008 Financial Crisis – most notably the impact on its physical storage system, where trader-owned and operated warehouses and long queues to remove metal were commonplace, and proving difficult to resolve.

The newish contracts were also a problem. Steel billet, launched at the worst possible time in mid-2008, was notable for low volumes and interest. The oddity that was plastic futures on a metals exchange was doing even worse, and was destined to be delisted.

Putting all that that to one side, though, the direction of travel was perhaps sign-posted in July 2010, when the LME opened its office in Singapore, and in conjunction with the SGX opted to introduce cash-settled mini-futures contracts to be traded and cleared on the Singapore Exchange. After all, Asia, and China in particular, were expanding markets and economies – where better for the LME to pursue growth opportunities and evolve?

With hindsight, however, the single event that was to have far-reaching implications and ultimately irrevocably change the nature of the LME was the July 2011 decision to consult on becoming self-clearing, removing that function from LCH Clearnet.

At the time this seemed to be just the next part in the LME bringing all the administrative activities in-house – contract matching and registration had migrated away from LCH Clearnet in mid-2009. This was another step in the path that LME CEO Martin Abbott had taken the market down since his appointment in 2006.

The member-owned private LME now had a Strategic Plan and was moving away from being a ‘not-for-profit’ market to a ‘let's-make-a-little-bit-of-money’ exchange, to the extent that it had paid its first-ever dividend to share-holders in 2009.

Whatever – the move to become a fully-cleared market was to put the LME on the list of potential targets for the world’s financial behemoths that had already snapped up many other small-to-medium sized futures exchanges.

But while ICE (Intercontinental Exchange) snapped up the IPE (International Petroleum Exchange) and London’s agricultural markets were acquired by LIFFE (London International Financial Futures Exchange) – which was itself eventually subsumed via Euronext and NYSE into ICE, the LME had remained immune to M&A interest.

That was hardly surprising, given the quirky uniqueness of the LME with its daily prompt date trading structure, preponderance of spread trading, close physical correlation and warehousing – not to say the three trading platforms of screen, phone and the supposedly outdated open-outcry floor.

But the move to fully-integrated administrative status, and the increased electronic trading that could unfold from that, had made the LME more attractive – a ‘must-have’ for some of its peers.

That became evident in September 2011, when the LME revealed it had received ten or more expressions of interest ahead of potential bids. At that time the LME’s share capital comprised 14.85 million ordinary or 10-pence shares and 2.49 million one-penny ‘B’ shares.

Conveniently, a couple of months later ring-dealer JP Morgan bought 600,000 ordinary shares at auction at just less than £42 each, which notionally valued the exchange at £640 million, giving interested parties a ball-park figure to pitch bids around.

So, at the February 2012 deadline for initial bids, six parties submitted offers ranging from £900 million to £1 billion, while offers said to be below £800 million were eliminated. In May, HKEX, NYSE Euronext, CME Group and ICE placed formal bids.

Most had increased their bids, so the LME board subsequently asked its sale adviser Moelis & Co to invite two of the four to a final round. This whittling down left HKEX and ICE, who resubmitted bids in June.

For any bid to be successful, a 75% vote from the LME’s 74 shareholders was needed. No problem, as in July the shareholders voted to accept the £1.388 billion HKEX bid at an EGM – which valued the shares at £107.60. This stock had been 10p when issued in 2000 – so big windfalls for the market, for sure, as JP Morgan, for example held 1.4 million shares.

Nothing was the same after that – within a year, Martin Abbott had stepped down as CEO, while a slew of other departures signalled the passing of the LME’s old guard. The new owners did guarantee that the floor would remain open until 2015 – as it turned out open-outcry continues to this day.

A new CEO – Garry Jones, formerly head of NYSE LIFFE – took over in September 2013, and had to shepherd the move to a more commercial, revenue-generating market, as well as grapple the hot potato of warehousing, which needed a bazooka, as HKEX CEO Charles Li memorably said.

The November2013 package of reforms met legal challenges, and, inevitably in the litigious-prone US, anti-trust lawsuits that trundled on for many months. 

Other changes were not so welcome, either – higher fees in the shape of a 34% increase were introduced from January 2015, while various incentives that seemed to encourage more algorithmic trading and individual monthly prompts looked like making the LME more akin to all the other futures exchanges, some felt.

Business, post-sale, has perhaps not grown to the extent that had been hoped, given HKEX’s links to mainland China.

Yet more warehouse reform proposals and consultations on greater access to Select, the electronic platform, added to Jones’s inbox, and made his spell as CEO not exactly a bed of roses.

However, it would have been naïve to expect the post-sale LME to remain much the same. New owners have new ideas, while looking to make a return on their investment.  And HKEX did show faith in open-outcry, when mandating a move to new premises in February 2016, with a purpose- built floor for the nine ring-dealing firms.

Change has been ongoing as well - in January 2017, Jones retired as LME CEO, with Matt Chamberlain appointed in April as his successor – the youngest head of a financial exchange, and who is still in situ now.  One of the hallmarks of the modern LME that he runs is a process of consultation and feedback and implementation, with changes, if necessary. 

In October 2017, then, the LME unveiled its Strategic Pathway Delivery plan, which is currently unfolding still, and entailed a programme of some carry fee reductions, OTC charges, new membership categories and share initiatives, among others. Warehouse reforms were brought in in November 2019.

Meanwhile, changes have been made to open-outcry times, while a trial was carried out on arriving at the nickel end-day close electronically – the jury remains out on whether that is the way forward for all the markets.  

And the latter part of the last decade has also witnessed changes on the product offer, with some contracts dropped, others brought in, and more to come. Floor-traded steel billet has gone, as has molybdenum, there has been tinkering with cobalt, while the over-complicated aluminium premium hedging vehicles found no takers.

On the plus side, the LME’s foray into precious metals has proved to be fairly successful, the revamped ferrous futures suite – cash settled – likewise. Alumina and aluminium are a work in progress, but the trajectory is in the right direction.

And what of the future?

Well, fees have gone up, an 8% increase, although this is the first hike for five years. Warehousing constantly evolves, with changes to QBRC (queue-based-rent capping) and LILO (load-in-load-out) rules on the way and off-warrant inventory reporting likely as well.

And with the current move towards electrical vehicles, hopes are high for the planned lithium futures contract. These will be cash-settled and not traded on the floor, like all the LME’s recent new contracts that have gained traction.

Indeed, that points the way to any future new contracts – it is almost a certainty that there will be no fresh open-outcry markets on the ring. There are nine ring-dealer companies now, and although there has been chatter for months about a new entrant in the wings, it is more likely that the next change will see a reduction in floor-trading firms – being a ring-trader is a high-cost business in what may be cash-challenging years..

That may not signal an end to ring trading, even though the nickel trial could be rolled out for other markets at some stage to gather more data. The LME electronic platform will notch up 20 years in February 2021, accounting for the vast bulk of business for well over a decade. Stubbornly, the industry is still wedded to floor-based price discovery for the key prices. 

But even if the floor did close and become history, it is unlikely that the 2020s, when looked back on ten years from now, will be as eventful, as far-reaching, and as game-changing as the ‘twenty-teens’. 


 

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