(Clyde Russell is a Reuters market analyst. The views expressed
are his own.)
By Clyde Russell
HONG KONG, June 26 It's no secret that gaining
access to China was the primary reason Hong Kong Exchanges &
Clearing (HKEx) bought the London Metal Exchange, but the vision
is a long way from reality.
As is usual with these deals, the theory looks sound.
Putting together the venerable LME with a dynamic Asian company
on China's doorstep looks like a perfect recipe to enter the
world's largest metals market, which so far has been largely
closed to foreign traders and investors.
"It sounds simple," was how Charles Li, the chief executive
of HKEx, put it at the LME Week Asia conference in
Hong Kong on Tuesday.
Li was no doubt trying to add a bit of light relief to his
address, but the scale of the challenge is enormous and its
success will not only depend on how the HKEx goes about it, but
also on factors well beyond the exchange's control.
The first steps outlined by Li include launching
yuan-denominated, cash-settled metals contracts in Hong Kong,
before an eventual move into other commodities and deliverable
It sounds like a good start, but the issue is going to be
how to get enough volume to make cash-settled contracts viable.
For metal producers, consumers and traders outside China the
contracts would have to offer some kind of advantage over simply
continuing to use the LME's deliverable futures.
The HKEx contracts would offer the advantage of being
settled in yuan, but this is a double-edged sword as long as the
yuan isn't a fully convertible currency and China imposes
In fact, the main problem for any plan to integrate China's
metals market, or any other commodity market, into the global
system is the issue of yuan convertibility.
While there are signs that the new Chinese leadership is
open to relaxing capital controls, the likelihood is that this
will be a protracted process characterised by a series of small
changes over time.
For yuan-denominated commodity futures, a slow process of
currency reform will make it harder to build up liquidity.
This will especially be the case if China's reforms to its
capital markets continue to exclude speculative investors, such
as hedge funds.
While the Chinese government may include increased yuan
convertibility in a package of reforms slated for October, it's
likely that restrictions will remain on hedge funds, and these
would likely to be the last controls to be lifted.
COMPETITION WITH SHANGHAI
There is also the question as whether the Chinese
authorities will be happy to allow HKEx a foothold in trading
commodities on the mainland.
Hong Kong often bills itself as the gateway to China, not
only for its physical proximity but also because of its
Western-style capitalism and legal system.
But it's also quite likely that the Chinese envisage
Shanghai as the main financial centre when capital controls are
While the LME Week Asia event attracted speakers from
mainland exchanges Dalian Commodity Exchange and Zhengzhou
Commodity Exchange, the Shanghai Futures Exchange (SHFE) was
notable by its absence.
The SHFE already offers metals contracts and has warehouses
as well, and it's well-placed to capture a slice of the global
metals market once China opens up trading to all comers.
Will there be room for more than one benchmark pricing and
trading platform in China's metals market?
Possibly, but it will be much harder for HKEx to succeed if
the SHFE also chases the market, and does so with the tacit
approval of the authorities in Beijing.
The main advantage for the HKEx is being able to leverage
off the LME's existing platform and reputation.
But replicating its success in Asia is far from a given, and
while Hong Kong is a financial centre, commodities trade has
generally been concentrated in fierce regional rival Singapore.
The physical location of an exchange isn't so much of an
issue. Convincing the trading community to move their business
is a major challenge.
HKEx's Li entertained the LME Week Asia dinner on Tuesday by
dressing up in soccer strip and wearing a David Beckham mask.
He said that after spending $2.2 billion on buying the LME
last year, he couldn't afford the services of the world-famous
While Li was amusing as Beckham, perhaps he should have worn
a Tom Cruise mask, because what his company is trying to do
appears to resemble Mission Impossible more than it does a
(Editing by Richard Pullin)