LME proposes to permanently shut ring, incentivize electronic trade

The London Metal Exchange is proposing the permanent closure of its open-outcry trading floor and the incentivization of greater liquidity on its electronic trading platform, LMESelect.

The proposals, laid out in a new discussion paper on future market structure, also include potential changes to the exchange’s margin methodology and the introduction of potential additional disclosures and policies to strengthen market conduct.

The proposals are designed to enable the LME to modernize and adapt to emerging trends and evolving customer needs, it said. The LME is not proposing to change to its unique prompt dates structure, including to replace it by cash-cleared, monthly contracts.

“We have huge respect for the ring. We are extremely mindful of the impact a potential closure could have on people in our ecosystem and it’s absolutely not a proposal that we are making lightly,” LME chief executive officer Matthew Chamberlain said in an interview with Fastmarkets.

“It’s absolutely one of the most difficult topics of discussion that I have been part of at the LME, but ultimately we feel that the responsible and right thing to do is to be honest about what we see as the right path forwards, and the reason we are having a discussion paper is because we want to hear what the market feels,” he added.

Responses to the discussion paper are invited until March 19, with the LME aiming to provide feedback and next steps before the end of the second quarter.

Trading ring
Trading on the LME floor, known as the ring, was suspended in March 2020 due to the Covid-19 pandemic, with activity moving to electronic pricing on LMESelect and the inter-office telephone market.

Although it has not been able to reopen since, the LME has continued to stress that the move was not permanent and that floor trading would resume when there was a broad end to social distancing in the United Kingdom, a vaccine, or some other technological innovations.

“Let’s be clear: if the pandemic situation in London resolves itself before we come out with the outcome of this discussion paper, we are committed to reopening the ring,” Chamberlain said.

“But on the other hand, we can’t ignore the fact that [LME trading] has gone well for the last 10 months and there is objective data that shows it’s gone well. The ring has been fantastic for 144 years, with great data showing it works really well. What we’ve never had before is any data showing that electronic trading either works or doesn’t work,” he noted.

In the past, the LME has explored further avenues of price discovery and settlement, most recently undertaking a trial to calculate nickel prices using a volume weighted average price (VWAP) method on LMESelect.

That trial, which took place for three months in 2019 and arose from the LME’s 2017 strategy discussion paper, closing prices for nickel carry trades continued to be based on ring trading, with a four-minute kerb session lasting from 16:55 to 16:59, allowing for a one-minute VWAP period.

The LME ultimately chose to keep its traditional open-outcry format for closing prices after the trial.

The electronic pricing trial did not provide the LME with full curve pricing, Chamberlain said.

“We’ve now got certainty that it works – unintentionally, we never planned to go and do that! – but we can’t just turn our eyes away from the fact that we have that data,” Chamberlain added.

“On balance, having gone through a very comprehensive process discussed with its board, the LME is saying, ‘look at the two sets of data, we on balance think the electronic route is the way to go.’ We’re discussing it with the market; it is not a foregone conclusion, we will hear what the market has to say,” he said.

Incentivizing LMESelect
Part of the proposals include incentivizing electronic trading in the member-to-member market; no changes are proposed for the market structure of the client-to-member market.

The LME is proposing to increase fees for inter-office member-to-member trades by around 50%, while reducing fees for electronic member-to-member trades.

“We believe flexibility and user choice is at the heart of what we do, so we want to give people the ability to keep using the inter-office or telephone market, but we believe that – in common with other peer venues – it is right that we ask people to pay more if they’re not taking part in adding transparency and liquidity to our central marketplace,” Chamberlain said.

“The flipside is that by reducing the electronic fee, we can further attract business to the whole LME ecosystem, which is good for the members and exchange because it’ll be cheaper to trade in an electronic manner on the LME,” he added.

Acknowledging that there might not be sufficient liquidity available on all dates on LMESelect, causing members to use the more expensive telephone market, the LME is also proposing to allow participants to conduct pre-execution communication on a bilateral basis, and then to transact or “cross” any resulting desired trades in the electronic market.

These rules, which are often referred to as “pre-execution communication” or “crossing” rules, exist in many other markets and would be called an “enhanced transparency cross” under the new proposals, the LME said.

The LME is also proposing to introduce a specific liquidity provider program intended to increase liquidity in its electronic markets, largely targeting carry trades in the front of the curve, in particular between the first four “third Wednesday” contracts and the three-month contract.

According to the LME, members who are able to transition some of their liquidity to the electronic market would benefit from a potentially lower electronic fee, and the liquidity provider program, which would offset the cost of the increased inter-office fee.

Chamberlain reiterated that the dates structure remained core to the exchange’s trading.

“The dates structure is at the heart of the LME and it would be irresponsible of us to try to change that not just in terms of our commitment to the market but in terms of our own commercial interests,” Chamberlain told Fastmarkets.

“We recognize that the daily price is embedded into physical contracts all around the world, and we would tamper with that ability to produce that daily price at our own commercial peril,” he said.

The daily dates structure and the tom-next (tomorrow/next day) roll market is extremely active on LMESelect, with participants who do not want to take delivery able to roll positions to the date of their choice.

While the LME floor has been temporarily closed, the cash price has shifted to electronic trade too, Chamberlain noted.

“The idea that the dates structure is incompatible with electronic pricing and trading, I think, is objectively false. All the data suggests that we can preserve and strengthen our dates structure electronically; I would not be advancing these proposals if I thought otherwise,” he added.

Margins, stocks
The LME is also revisiting a proposal to transition to a different way of calculating its clearing methodology.

Currently, variation and initial margining for LME Clear operates under a Discounted Contingent Variation Margin (DCVM), which realizes forward profits until the settlement date. This, along with the dates structure of the exchange, is a key reason why the LME is often described as a forward market rather than a futures market.

The alternative option is to use a Realized Variation Margin (RVM), which pays profits on a trade date + 1 basis.

A potential move to RVM was rejected by members in 2017 amid concerns it would make the provision of credit lines expensive and result in the rapid withdrawal of credit line capabilities.

The exchange is also seeking comments on whether to introduce additional disclosure mechanisms to increase transparency, such as a regulatory news service for intentions regarding stock warranting or cancellation activity.

The LME may explore requirements to disclose certain physical transactions above specific size thresholds if participants believe this would be of benefit, it said.

It is also seeking views on policies that would reduce the potential for market squeezes on the LME and over-the-counter (OTC) markets. These include rules to limit one party’s ability to acquire significant holdings of new or remaining warrants, the introduction of specific outright position limits to address potential squeezes further down the curve, and regular reporting of OTC positions.

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