I return again to the subject of electronic and algorithmic trading. Let me start by saying I have no interest in turning the clock back, nor am I indulging in rose-tinted hindsight.
Electronic trading is here to stay, and not only in base metals, but in other commodities, equities, foreign exchange, bullion. Everything is available to trade online. But, that doesn’t mean that we should accept what is in place now and assume that the status quo should rule. Interest in industrial base metals has risen hugely over the last decade, and investors increasingly talk about their need, or desire, to have exposure to this asset class.
Since in one way or another we’re pretty much all investors, we should probably be pleased to see fund managers diversifying their portfolios. After all, once the dotcom bubble burst, then the sub-prime bubble burst, why wouldn’t we want them to be looking for the next big thing?
So, there’s a lot more money being aimed at the London Metal Exchange market, and that has necessitated a rethink of the way access to the market is offered to those who want to be involved. That’s where Select has come from.
I have previously put forward some of my reservations about the effects of electronic trading, some of which have been debated coherently by the Duke of Deptford and commented on by others, and although I don’t necessarily agree with everything that’s been said, I do understand that we are where we are and Pandora’s box – unleashing lots of bad things but also hope – is open and will not be closed.
But I still have concerns about the security of what may be plugged into Select. While the LME’s system is directly used only by members, all of whom are margined and guaranteed at the Clearing House, that is not the case two or three removes down the line. Do the order routing systems have sufficient functionality not only to monitor credit line availability, but also to prevent orders being placed if that availability is not there?
The telephone a/es were always in the past in a position to prevent over-trading. Obviously there is the risk that they might be less than diligent in policing putative over-trading, but the question really is whether or not one would prefer an a/e, employed by a broker, sitting in that broker’s office or a computer trading system monitoring credit exposures.
It’s a genuine question, which requires a definitive answer.
Are order-routing systems required to demonstrate to the LME and the Clearing House that their functionality in this area is sufficiently robust? Or is it left to the individual member to give their clients what they perceive to be adequate?
The argument about increased transparency is, I think, flawed. Certainly, we can now all see trades as they are executed, through the electronic platform, but to suggest that we have any better idea of available liquidity is naïve. Pinging, fishing, icebergs – there’s plenty of literature on algorithmic trading without me adding to it here – all these, and other, activities serve to conceal liquidity, not make it more apparent.
It is arguable, and I would probably agree, that there is no reason why liquidity should be visible to all market participants at all times, but since this is advanced as a positive benefit of electronic trading, we should consider the reality.
Algorithmic trading is a perfectly legitimate activity, and LME Select is an excellent platform on which traders can efficiently execute their business. My issue comes where the algos are plugged directly into Select, which I contend disadvantages some legitimate users of the LME – and since we actually want all the possible volume on the market to improve the liquidity, it doesn’t make sense to alienate some users.
So why not do it this way? Algorithmic traders can do what they like on their own computer systems, hedgers can formulate their orders however they wish, but at the point at which the order is entered onto the Select order book, it should be done manually. In other words, nothing should be plugged electronically into Select.
I’m not trying to turn the clock back. The quid pro quo would be a far wider availability of Select. The platform should be made available to anybody who wants it, provided they can demonstrate that they have an adequate clearing arrangement with one or more of the LME’s clearing members. That way, traders still have the ability to input orders directly, but they all do it via a human, manually, to keep the playing field level. After all, the real goal should be a market which satisfies the maximum number of its constituents.
In the past, the somewhat cliquish, peculiar nature of the LME deterred parts of the mainstream investment industry from participating. We have moved beyond that now through sensible structural changes to the market and its operations, but it would be a shame if the pendulum swung too far the other way.
