Raising fees could imperil LME date structure: a broker writes

The London Metal Exchange plans to introduce a fee for client trades from March. The proposal has aroused some opposition, and prompted one broker to write to Metal Bulletin in response, requesting anonymity. Here he outlines his concerns. How justified are they? Email aharrison@metalbulletin.com, or tweet @aharrison_mb

The politics of the London Metal Exchange is usually confined to the boardroom and rarely impinges on the end clients.

But the LME board’s decision to raise fees points to a more confrontational attitude from some board members to the clients of the exchange.

The costs to the users have been documented elsewhere, but let us consider the rationale.

That the LME is preparing itself for sale is a matter of public record, and some board members feel that to enhance shareholder value, it is necessary to raise revenue through higher fees.

Both cash flow and reserves increase, thus adding expected value to the company and providing a platform for development of the LME’s own clearing function.

But the complexity and the flexibility of the LME mean that higher revenues will not necessarily result from this move.

The LME board maintains that the increase in fees, which is intended to drive up revenues, will be passed to the end clients and will bypass the members.

The question is how?

Traditionally LME brokers charge an all-in commission that contains the exchange, clearing and execution fee.

Individual costs are not identified — and further, fees of any type for small date adjustments are not charged at all.

If LME brokers and clients act rationally (and that, in my experience, is not a given) brokers will either raise rates to the end clients or depress their clients’ need to execute short-dated carries. For example, a client who rolls 500 lots TOM-NEXT should now pay GBP500 in exchange fees for the privilege.

Either the broker will charge the client directly or widen the client fill post execution, or more likely he will advise the client to roll a minimum of TOM-2 WEEKS.

The client will probably have no interest in paying an extra GBP 500 each day, and will elect to do the longer single TOM- 2 WEEKS trade.

The result is the huge volume of TOM-NEXT executed each day will decline and LME revenue with it.

There is a ground-swell of opposition to the fee increase from both members and clients, because the current charging model suits everyone.

Certainly the fee issue has hardened feeling within the board rooms of the brokerages, as they do not want to see the current business model of the date system changed.

The brokerages understand that if the LME makes the daily prompt date system more expensive, then the daily prompt date will become vulnerable to change, and the bulk of LME brokers’ business models with it.

It is always useful to look at an issue from its two extremes.

So take scenario one: nothing happens; the clients pay the additional fees; the LME’s revenues grow; and the world turns as usual.

Or scenario two: clients, in an aggressive search to control costs, start to route orders to the relevant third Wednesday prompt date as a proxy for the three months and the market moves to a de-facto monthly contract.

The LME board may calculate that scenario one is the more likely.

It is, though, opening the door to the possibility of scenario two, which would be a disaster for both exchange and broker revenue — but a triumph for clients.

This issue illustrates the dilemma for any buyer of the LME, in that the buyer will have to raise fees, otherwise the expected purchase/value figures do not add up.

In doing so however the buyer actively invites a rationalisation of the trading methodology, and may therefore see the income from his investment fail to reach the levels that would justify his purchase.

For the LME to be sold 75% of the shareholders must accept the offer.

More importantly, only 25% of the shareholders are needed to reject the sale entirely.

Sir Brian Bender should be making a few discreet calls to find out how many shareholders would currently vote against a sale, and to establish what kind of headwind the LME has on this issue.

I feel certain many shareholders will advise him to urgently change direction.