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24 June 2020

The Passing Bell



We’ve written a couple of times here before about the closure and (potential) re-opening of the LME Ring, and speculated to an extent on whether or not it will happen. 

First of all, it is important to acknowledge that as a price discovery method, open outcry undoubtedly has a lot to recommend it. Just a casual perusal of the newspapers of the the last ten years or so will demonstrate that those markets which have operated on the basis of a ‘fix’ have suffered from the threat and in some cases the reality of manipulation, while the issues that have bedevilled the LME have had more to do with  storage and warehousing than with reliable price discovery. After all, it was for alleged wrongdoing in the interest rate market that poor Tom Hayes received his outrageous sentence, and investigators have spent plenty of time looking at FX and precious metal fixes. (Incidentally, I heard a member of the executive of one market - it doesn’t matter which which one - recently pointing out that “we don’t use the word ‘fix’ any more”. Which may help explain the problem…….)

So open outcry can hold its own more than adequately, on the basis that any price arrived at in the Ring is tradable, and thus should be less prone to game-playing. So far, so good. But what we have at the moment is not open outcry; it is an electronic representation of it, with the ‘outcry’ element silenced by the pandemic. In fact, what is producing the closing price (and thus the global reference price) is a volume weighted average of the (five minute) trading period leading up to what would be signified by the closing bell. That sounds fine, and is by all accounts working well and making no problems.

However, in its very success, I have a feeling it may be creating and storing up an issue which may come back to bite the LME when working conditions are normalised and they look to re-open the Ring. 

Think of it this way. We can all remember the close of  the official Rings - the noise, the excitement, the shouting and the eventual satisfaction on the face of the dealer who managed to be the last man or woman shouting as the bell rang.  That was it, from the establishment of the formal market until a couple of months ago (with very few exceptions), and it was successful - it produced a reference price, it was a piece of theatre that the LME could usefully use as a bit of marketing spiel, and it could always point to the fact that it was tradable (so if you didn’t like it, you had the opportunity to do something about it) to give it a legitimacy which may have been missing in other markets. 

But, as those of us whose careers have centred on the LME know, there were always other potential forces at work. A loud voice; a dominant personality; a strong reputation - these have also been factors in establishing closing prices, and - as those of us with long exposure to the LME will confirm - have sometimes enabled the talented ring-dealer to establish a close which does not necessarily reflect the weight of volume to be traded. From the point of view of the insiders - nothing wrong with that, it’s how the game works. That’s why some of the dealers command far greater remuneration than others.

But step outside the inner circle for a moment, and then look at it. Most users of the market - at least, most industrial, hedge users, to whose importance the LME has always been keen to pay lip service at any rate - would probably prefer a close which was in line with the volume of trade going through. That way, the hedge works better, rather than being potentially bent out of shape by an unrepresentative close. And that’s why the appearance of those two words ‘volume weighted’ in the rubric surrounding the explanations of the current electronic system is so important. I fear - because actually, I like the Ring, its drama and visual excitement  - that having tasted the volume weighted game, the wider business may seek to continue along that road and thus we may be very close to hearing the passing bell.

For those not familiar with funeral rites, historically, in England, there were three bells tolled around about death. The first - often rung while the person was still dying - was the passing bell; the second, rung at death, was the death knell; and the third was the lych or corpse bell, rung as the funeral procession approached the church.  

Let’s hope I’m wrong; but given the trajectory of the world right now, I’m not too confident.

For those readers not familiar with how the LME official ring closes may be used and abused, the opening chapter of ‘Tarnished Copper’, by Geoffrey Sambrook, available on Amazon, may open some eyes………. 

 

    

  

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