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According to Matthew Chamberlain, the results to date have produced a close alignment with current pricing practices, which calculate the volume weighted average price (VWAP) using the most liquid three-month contract, and a “last price” methodology, combined with judgment from the LME’s trading operations team for all other prompt dates.
“In general, there is a very strong alignment, and where there isn’t, our team digs into exactly why – and generally, it’s because there’s been a difference between where the contract traded during the majority of the pricing window and where it traded at the end,” he told Fastmarkets in a recent interview.
“I’m not suggesting one price is right or wrong, but even when there are differences, you can very clearly explain them,” he added.
The changes will start from January 2024 and affect the LME copper, aluminium, nickel, zinc and lead contracts. The move follows an industry consultation and will see the LME amend its VWAP methodology to include cash, three-month and the first four third-Wednesday monthly contracts in all its base metals contracts except for tin.
The aluminium and lead contracts will be the first to adopt the methodology change with effect from January 22. This will be followed by the copper, zinc and nickel contracts on March 18.
The exchange is phasing the implementation to ensure participants have adequate time to prepare for the changes, Chamberlain said. The LME has also made several modifications to its plans, particularly around timing, to give the market more time to prepare for the changes, Chamberlain noted.
“A lot of people came to us and said, we need time to build some algorithms to help us trade the closing price, or to get our teams used to it, to do a parallel run internally,” he added.
While it marks a significant change from the current pricing methodology, copper and aluminium will eventually have just seven out of a total 123 dates calculated by the expanded VWAP and the remaining 116 dates by the current “last price” and expert judgement methodology, Chamberlain told Fastmarkets.
He said the exchange’s “evolutionary journey” with VWAP had required several behavioral changes from its members. It had also, he acknowledged, led to concerns the LME was moving too far down the electronic path or that its members wouldn’t be in a position to guarantee prices.
That journey began in 2019, when the LME began a trial in which the three-month nickel closing price was determined exclusively by reference to an LMEselect pricing window via the VWAP function. Following the trial, the close prices returned to the ring, and the LME extended a consultation period about the use of electronic close prices.
During the Covid-19 pandemic, the LME ring suspended trading and moved to fully electronic pricing. When the ring reopened in September 2021, closing prices continued to be determined electronically, and only official prices returned to ring trading.
“This extension of VWAP is a significant change, but I’m confident about it. I speak to a lot of clients and members who say that they’re confident as well, although you never want to blasé about these things,” Chamberlain said.
“We heard lots of views in VWAP consultation, and on balance, they were orientated toward change,” he added.
Chamberlain noted that calls to expand the closing price methodology came primarily from the financial market sector who prioritize the closing prices. At the same time, the consultation highlighted that the physical community did not want to lose the open outcry trading ring for the lunchtime official prices, he said.
The LME is gearing to release the results of consultations launched earlier this year to provide greater visibility of the build-up of warrantable material in its warehouses, Chamberlain said.
In February 2022, the LME introduced off-warrant stock reporting to increase transparency.
It is now proposing to extend these requirements to include all unwarranted metal in LME-licensed warehouses that could be warranted in the future.
It is also proposing to make permanent a backwardation limit on tomorrow/next contracts and a delivery deferral mechanism. These were implemented last year to help mitigate the potential effects of low-stock environments and enhance the LME Group’s deferral powers, the exchange said at the time.
“What I can say, without giving too much away from the consultation, is that there is a genuine desire to have more transparency in the LME market, and so I think the consultation has been very well received,” Chamberlain told Fastmarkets.
The consultation will address questions raised around practicalities, including exactly how the rules would work, and around complexity, such as how warehouses would administer the new requirements, he said.
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