HOTTER ON METALS: Warehouses in drive to sway reform pendulum
When the London Metal Exchange finished its 12-step warehouse reform package, it proved once more that you cannot please all of the people all of the time.
It faced some inevitable criticism of the rules, in particular that the LME went too far in certain areas and should consider tweaking or rolling back some of its reforms.
In particular, the focus of attention was on the load-in, load-out (LILO) regime and queue-based rent capping (QBRC).
The results of a discussion paper last year showed that “most warehouse operators” would like those rules to be repealed or reduced in scope.
In contrast, other market participants – and particularly consumers - were opposed. These participants wanted to give the new rules enough time to operate before taking steps to rein them in.
A year-on, warehouse operators are making another concerted attempt to change the rules.
For some time, a sub-committee of the LME warehouse committee has been working on proposals they say will ease the restrictions on deliveries and queues. This will attract more metal into warehouses, they say, amid on ongoing pattern of metal moving off-warrant.
Total stocks in LME-listed warehouses are currently around 1.8 million tonnes, down from their peak of 7.6 million tonnes in July 2013, when aluminium stocks accounted for 5.47 million tonnes.
The work of this group has been ongoing with the blessing of the LME, which has adopted an open mind to change if it in the interests of all market participants; it has always said its role is not to interfere in the dynamics of the metals market.
The key goal for the exchange will be to ensure the massive queues that developed in prior years, particularly in Detroit, United States, and Vlissingen, the Netherlands - and the negative headlines that came with them -, do not return.
Now the LME is preparing to take these suggestions to the broader market in the form of a discussion paper.
So what exactly are warehouses proposing?
The key aspect is to get rid of LILO and QBRC and replace them with a new, simpler rule requiring warehouses to load a percentage of their metal out daily. The suggested target percentage is 1.5%, lower than the 2% in place at CME Group’s Comex warehouses.
A percentage target is something that the LME considered but eventually decided against in the past given high levels of LME stocks. Theoretically, it could now work given the sizeable reduction in LME stocks over the past few years.
In practice, it could lead to queues of around 67 working days, which, when weekends are included, is around 96 calendar days.
Some physical consumers are likely to object on the grounds that the percentage rule would increase the number of calendar days warehouses could charge rent for metal in a queue – right now, the rules allow for 30 days full rent and 20 days half rent, or 40 days equivalent. After 50 days, rent is free.
For sure, there is a cyclical element to the decline in warehouse stocks. But warehouse owners have seen their business models decimated with several withdrawing or downsizing their LME activities.
Market users have also found alternative financing options outside the LME-approved network, leaving warehouse stocks at continually lower levels.
The sub-committee had also looked at the possibility of a ban on rolling warehouse rent agreements, known as evergreen deals, which have lowered the cost of storage as warehouses are motivated to cut prices in fear of losing metal to competitors.
It has also led metal to be taken off-warrant in one warehouse and placed back on warrant in another competitor’s warehouse in the same location, a process known as destocking.
That proposal has already been to the LME Physical and User Committees, both of which argued the exchange should not attempt to legislate against commercial arrangements, which are out of the LME’s jurisdiction.
This opposition meant that evergreen deals have not made it onto the proposed reform paper; the LME would have been unlikely to want to go down a path that could lead to threats of lawsuits on anti-competitive grounds either.
Whether a compromise between the financing community and warehouses can be found remains to be seen.
What is more certain is that prior to the LME warehouse reform package, it was too easy to put metal on warrant and too difficult to take it off. Now the pendulum has swung the other way and that situation has reversed. Some kind of middle ground, whether realistic or not, would be ideal.