London Metal Exchange debates its future
The FT's Henry Sanderson reports from the London Metal Exchange, the world's oldest metal exchange and the last open outcry trading floor in Europe, about whether it should modernise its business.
Produced by Vanessa Kortekaas. Filmed by Petros Gioumpasis. Still images by Getty.
In some ways, not much has changed at the London Metal Exchange since it was founded in 1877. Today, traders still stand around a ring and shout orders that help set the global price for everything from the aluminium we use in our cans to the copper in our wires, and increasingly, the nickel used in electric car batteries. A total of $10 trillion worth of metals was traded on the LME last year, roughly 40 times world production. Prices set here can upend industries across the globe, causing mining companies billions of dollars in losses or profits.
Despite its modest surroundings, the LME is the world's oldest and most preeminent metal exchange. Though trading no longer takes place in London's coffeehouses, the LME is actually the last exchange in Europe to have this open outcry trading floor. But for perhaps the first time in its history, the LME's future is in doubt. For most of its history, the LME was owned by its members. But its sale to Hong Kong Exchanges and Clearing for over $2.2 billion in 2012 quickly changed all that. The new owners raised fees to recuperate some of their investment, but that upset brokers and others in the metals community. And since then, volumes have been dropping. Last year, total trading volumes fell by 8% compared to a year earlier. And in the last few months, both the chief executive and the chief operating officer have left the exchange.
Many people believe that this London institution and its next CEO will rethink its strategy and potentially add additional metals to its core offerings of aluminium and copper.
A key part of the reform debate is the LME's date structure. The ring sets the final closing price for metals traded on the LME, which is the price you see in your newspaper the very next day. Every day, buyers and sellers trade metal for delivery three months later, but that's based on the time it took in the 19th century for ships to go from Chile to the UK to deliver copper. But other exchanges have standard monthly futures contracts. So a key part of the question is, is the LME's date structure still suitable in a world where trading takes place in less than a millisecond, rather than months?
The extreme case is to abandon the date trading system and to abandon the ring trading, and turn the market simply into another electronic platform that sits on everybody's desk. That would obviously reduce the costs and it would probably solve the problem in one way. I suspect that we will see the market being moved away from the non-ferrous business, which will make a lot of people unhappy. But at the same time, there are an awful lot more people who are investment players. And if they want to attract new investment money from China, which has been one of their stated objectives, then presumably they will have to simplify the structure of the market as well.
Leadenhall Market is where, for decades, metal brokers have come to socialise. And in the days before mobile phones, when the LME was situated just around the corner, you could pretty much guarantee you could find any metal broker or dealer in these pubs. Now, however, many of these brokers believe that reforming the LME too quickly could risk its historical heritage, and really what makes it unique.
If it loses its unique selling points-- and to be fair, the date system, possibly the ring is an argument-- and they just become a monthly trading contract, they'll become like the CME and every other exchange, which is a me-too solution. So they have to be very, very careful in reform they don't actually destroy some of the fundamental building blocks that brought the LME, in fairness, to where it is today. They have to get back and listen to their core customers, because that's the biggest complaint you get from clients. The trade feels almost isolated.
So will the LME reform its historical date structure?
At the core of the date structure is our ability to produce a daily cash settlement price, which is discovered on the floor behind me and is then embedded into the vast majority of physical supply contracts in metals, for metals users and producers around the world. I don't believe that anybody is saying that that's a bad thing, that we would ever want to move away from that. That is what is unique about the LME. It's what solidifies our relationship with the physical market and it's something that we are totally committed to preserving.
We're being asked, as the LME, can we preserve what is good about our physical market relationships, but also grow our user base, grow our participation, grow our volumes in the financial space? We clearly already have significant financial participation, but we're now being challenged by some of those financial players as to whether we can deliver a market structure which is more suitable for their type of trading.
Right now, neither the reformers or those who want to keep the exchange as it is are happy. Reforming this ancient exchange is likely to be a delicate task. The new CEO will have to find a way to please both crowds, or at least get the majority of the users in agreement on the best path forward. But one thing is increasingly clear-- if the LME does nothing, they risk losing out to other metal exchanges in the US and China.
Henry Sanderson, Financial Times, London.