Warehouse operators can finally take stock after three tough years – the London Metal Exchange (LME) has reached the end of its warehouse reforms.
Following the purchase of the LME by Hong Kong Exchange & Clearing (HKEX), the exchange introduced a 12-step programme to reduce queues at LME sheds.
The jury is still out on whether the measures have been a success. The LME claims that it has achieved its goal – warehouse queues have declined – but market participants have countered that the reforms are having a damaging effect on LME business.
Of all the measures, queue-based rent caps (QBRC) provoked the biggest market reaction both before and since their implementation.
“QBRC is the biggest issue – [we’ve] certainly seen more volatility on the front curve and backwardations. There has been a lot [of metal] cancelled in Vlissingen and this has meant that aluminium here is no longer infinite and there is not a perpetual contango,” a source said.
The reform package is moving the exchange in the wrong direction, a source told Metal Bulletin.
“The LME is feeling the heat,” the source said. “Volumes are down in affected and unaffected warehouses and it is moving… towards not being a physical exchange – the exact opposite of what they are saying.”
A second warehouse source complained about the massive decrease in visibility in market dynamics, pointing the finger of blame firmly at QBRC, and the magnitude of the changes the LME has introduced.
Since the advent of the 2008 financial crisis and the influx of aluminium into warehouses for financing purposes, warehouses have been able to cash in on the queues of metal that have built up.
Everything the warehouses did was within the exchange’s guidelines – they simply used the rules to their advantage. But this meant that much of the metal in warehouses was not available for physical delivery – it was tied up in financing deals as a means for investors to make money in an environment of low interest rates.
But the volume of complaints about soaring premiums and long wait times to receive metal prompted HKEX CEO Charles Li to say during LME Week 2012 that it intended to take a “bazooka” to the queues if necessary.
New regulations, consultations, discussion papers, legal tussles and threats have flowed since. Below is a timeline of events since Li first took aim with that now-infamous bazooka.
SEPTEMBER 2016 – LME says it understands that some market participants see its new warehouse regulations as too complex but it also worries that future attempts to streamline them might muddy the waters further.
SEPTEMBER 2016 – LME decides to implement charge capping (CC) measures for warehouse operators as the final part of its reform programme. The schedule of charge caps will be frozen for five years, during which time ‘real-world’ prices are expected to converge closer with the frozen published rates. After that, the maximum prices will be updated annually, based on the per-country consumer price index (CPI).
JULY 2016 – Metro International agrees to pay a $10 million settlement to the LME for alleged breaches of the exchange’s warehouse agreement. The alleged breaches were in relation to transactions made over September 2010-2013 during which time the warehouse company was owned by Goldman Sachs.
JULY 2016 – LME initiates a market-wide consultation proposing to control warehousing costs by imposing caps on maximum charges. If enacted, the first capped charges would come into effect on April 1 next year. The exchange proposes to set the initial schedule of maximum rates for warehouse rents and free-on-truck (FOT) charges by calculating the average of the highest published charges for the years 2015-16 and 2016-17 on a per-metal and per-country basis.
JULY 2016 – The LME will not consult on an FOT conversion as part of its warehouse reform due to lack of appetite. Market participants did not expect the exchange to push ahead with changes.
MAY 2016 – The LME “anticipated” a further fall in aluminium stocks in listed warehouses this year after the introduction of QBRC and does not feel this will affect price discovery, it says.
APRIL 2016 – LME releases discussion paper on warehousing charges outlining possible reforms to the LME physical network. The exchange is confident it can reach an agreement over warehouse reform but acknowledges there could be legal ramifications if it were to force warehouses to cut FOT rates.
APRIL 2016 – But market participants warn that the current ease with which LME price spreads can be squeezed into backwardations will be exacerbated if the exchange implements its proposed reforms. As well, aluminium stock levels in the LME warehouse system could slump. The LME might struggle to get approval for and then implement its proposed changes to a system where the FOT change is met by the seller rather than the buyer.
MARCH 2016 – Warehouse operators registered with the LME brace for an extended struggle with the exchange over its proposal to implement CC on rents and FOTs.
FEBRUARY 2016 – Two warehouse operators reduce their proposed 2016-2017 LME fees, lowering the average increase in warehouse rent among LME-registered warehousers to 7% from the previous average of 10%, after the LME offers a ‘one-off’ two-week window to do so.
JANUARY 2016 – Warehouse operators may take legal action against the LME should it press ahead with CC.
JANUARY 2016 – LME saw more deliveries out than in on average in 2015, with outflows especially evident in aluminium and zinc.
DECEMBER 2015 – LME says it is reviewing what it regards as “out-of-line” rent and FOT fee increases.
DECEMBER 2015 – Warehouse companies submit increases – some significant – in rents and FOT charges – to the LME for the year from April 2016 to factor in tougher rules on load-out requirements and queue control. Metro International proposes considerable fee increases while Pacorini surprises with only modest rises.
DECEMBER 2015 – LME will have total visibility on warehouse incentive levels from April after a new reporting rule is implemented but it will be accommodating as long as inducements are not related to queues.
NOVEMBER 2015 – LME will introduce QBRC as planned following an extended consultation that also covered load-out rate increases (LORI) and anti-abuse measures.
SEPTEMBER 2015 – LME will extend its warehouse consultation by two weeks to seek feedback on amended proposals for its QBRC rule. It is still “minded” to introduce QBRC but its two-week extension will allow for comments on proposed anti-abuse provisions – an attempt to alleviate warehouse owners’ fears of manipulation.
SEPTEMBER 2015 – QBRC will be detrimental to the exchange if introduced, Alcoa warns in a letter to the LME.
SEPTEMBER 2015 – LME will look at introducing position limits for its forthcoming premium hedging contract as part of a broader consultation with interested parties.
AUGUST 2015 – US aluminium producer Alcoa meets with the chairman of the Commodity Futures Trading Commission to discuss the LME’s proposed warehousing reforms.
JULY 2015 – Alcoa sends a letter to the CFTC related to LME warehousing policies.
JULY 2015 – Litigation against the LME is “highly likely” should the exchange go ahead with a proposed cap on the rent charged for metal caught in queues, several warehousing sources tell FastMarkets.
JULY 2015 – LME launches a market-wide consultation on recommendations to LORI for metal stored in exchange-approved warehouses and to introduce QBRC. The exchange submitted its proposed consultation into QBRC to intensive legal scrutiny to ensure that it could stand up in court should it go ahead, it says.
JUNE 2015 – Alcoa asks CFTC for documents that relate to the regulator’s level of influence over LME warehousing reforms.
APRIL 2015 – The CFTC officially defers an application from the LME to register as a foreign board of trade (FBoT), citing worries that the exchange has not yet made enough progress on warehouse reforms.
MARCH 2015 – The LME has not yet made a decision on the capping of rents for metal stored in listed warehouses.
FEBRUARY 2015 – The LME says it will introduce fresh regulations and carry out further discussions with the market concerning the storage of metal.
DECEMBER 2014 – Warehouse companies will introduce marginally higher rents and FOTs charges for storing metal under warrant in recognised sheds for the year starting April 2015
DECEMBER 2014 – The UK’s Financial Conduct Authority (FCA) adopts a new strategic approach to ensure it can meet forthcoming regulatory challenges.
NOVEMBER 2014 – Goldman Sachs, other banks and metal traders are accused of participating in manipulative “merry-go-round” trades that artificially inflated warehouse queues, leading to a disruption of market fundamentals and higher costs for consumers, according to an explosive report from the US Senate Permanent Subcommittee on Investigations.
OCTOBER 2014 – LME begins a two-week consultation with listed warehouses regarding its intention to implement the LILO rule as of February 1
OCTOBER 2014 – LME wins its appeal against Rusal at the UK’s Court of Appeal, allowing the exchange to implement its new warehousing rules as planned.
SEPTEMBER 2014 – Warehouse operators are already behaving as if LILO been introduced, a business strategy that has had a mixed impact on queue length, the LME says
SEPTEMBER 2014 – Three US Senators strongly urge the CFTC to scrutinise the LME’s application to become an FBoT.
JULY 2014 – UK Court of Appeal decides to reserve judgement on the LME’s appeal.
JUNE 2014 – LME confirms that it will appeal on July 29 and 30.
MAY 2014 – UK Court of Appeal grants LME leave to appeal.
APRIL 2014 – UK High Court tells LME it cannot appeal against its late-March ruling.
MARCH 2014 – Judge Justice Phillips finds that the LME’s original consultation and subsequent proposed rule warehousing changes were ‘unlawful’ and ‘unfair’, leading to the suspension of LILO.
FEBRUARY 2014 – LME fires back at Rusal, claiming that its new load-out regulations were devised via a rational, prudent and considered process and that Rusal’s contention is ‘groundless’.
FEBRUARY 2014 – Rusal contends that proposed warehouse load-out regulations would cause ‘severe hardship’ to aluminium producers.
DECEMBER 2013 – Rusal seeks to challenge LME decision to change its warehousing policy, alleging that the consultation was unfair and procedurally flawed, that the proposed changes are irrational and disproportionate and that Rusal’s human rights had been breached.
NOVEMBER 2013 – After a lengthy consultation period on how best to tackle warehouse queues, the LME says it will implement LILO.
SEPTEMBER 2013 – Russia’s UC Rusal calls on LME to postpone warehousing changes, saying these could distort the market.
AUGUST 2013 – In a second lawsuit, aluminium user Master Screens accuses LME, alongside Glencore Xstrata, JPMorgan Chase & Co and Goldman Sachs, of market manipulation and anti-competitive practices. LME says the suits are without merit and it will contest them.
AUGUST 2013 – Superior Extrusion issues US lawsuit alleging anti-competitive and monopolistic behaviour in warehousing market in connection with aluminium prices to Goldman Sachs and LME. Exchange says it will contest it vigorously.
JULY 2013 – Goldman Sachs offers swaps for immediate delivery metal to end-users in Metro Detroit warehouse queues. No takers emerge.
JULY 2013 – HKEx/LME propose new warehousing rules, linking the daily load-out rates to the daily tonnage being delivered into the sheds (LILO). The proposal targets only those warehouses with queues of more than 100 calendar days. The exchange will have the final say in proposed changes to its warehouse regulations even after starting a consultation period to tackle the issue of long queues.
DECEMBER 2012 – LME announces it will alter its warehouse delivery rates from April 1.
NOVEMBER 2012 – LME proposes changes to regulations: an extra 500 tonnes per day of non-dominant metal must be removed in addition if requested and if there is 30,000 tonnes or more of cancelled warrants of a single dominant metal.
OCTOBER 2012 – HKEx CEO Charles Li says he will take a ‘bazooka’ to warehousing issue if required.
(Editing by Mark Shaw)