* Change of regulation will drive up costs, hurt free credit
* New rules could erode LME volumes, which hit record in April
* LME's new Hong Kong owners need to justify $2.2 billion price
By Susan Thomas and Maytaal Angel
LONDON, May 3 Companies using the London Metal Exchange say new EU rules for financial markets after the 2008 crisis may prompt it to quit Britain's capital after nearly 150 years for Hong Kong, home of its new owner.
The bloc's European Market Infrastructure Regulation (EMIR) aims to bring clarity to opaque derivatives markets with mandatory clearing, reporting of contracts to trade repositories and, in some cases, higher capital requirements.
While regulators hope the rule changes by the European Union will bring stability after the global meltdown, brokers say they will drive up costs at the world's biggest marketplace for industrial metals such as copper, aluminium, nickel and zinc.
More importantly, the regulations will restrict the ability of brokers to grant clients the free credit that defines many of their business models and hit over-the-counter as well as on-exchange contracts, brokers and lawyers say.
Less credit will mean reduced LME volumes and liquidity.
LME Chief Executive Martin Abbott has criticised "poorly conceived regulation" and dropped a heavy hint at relocation.
"We are in a global market and if what was previously considered unthinkable is now made preferable, then so be it," Abbott said at a copper conference in Chile last month.
The LME said on Thursday that Abbott had made clear there are no plans to relocate the exchange.
But members of the exchange, on Leadenhall Street near the Bank of England, say relocation is an option, maybe not now but possibly in the next decade. Such a move would end the LME's prized "open outcry" shouted trading across a circular floor.
A logical move would be eastward as the LME was bought last year by Hong Kong Exchanges and Clearing (HKEx), which runs the Hong Kong stock exchange, for $2.2 billion.
GO FULLY ELECTRONIC AND MOVE
"The LME could indeed consider moving to Hong Kong - why not? They're owned by HKEx now, and China consumes 50 percent of the world's metals," said the head of a LME brokerage unit who asked not to be named.
"If you make all these rules and make it extremely costly to operate here, they could say 'OK, run the trading floor for another five years, then do away with the floor, go fully electronic and move.' The new owners need to see a return on their investment."
Another possibility might be to develop across both centres.
"When it comes to new product launches, the LME would then be looking at whether...to launch in Hong Kong or London," said John Wall, chief executive of brokerage Marex Spectron.
The LME hit record trading volumes last month and average daily volumes have been up 6 percent so far this year compared with the whole of 2012 - good news for HKEx.
"If those volumes are going to be adversely affected because of regulations in Europe, then I think anybody sensible would be looking to see what they can do to alleviate those problems," said the head of a brokerage member of the LME.
An official of the European Commission said it was happy to talk with the LME to understand the exchange's concerns.
"But this is something that's going to become the market norm and will apply to all clearing houses, clearing members and clients and is aimed at the protection of client assets," the policy officer, at a Commission unit dealing with EMIR, said.
For many metals brokers, EMIR's rules for clearing houses will hit at the heart of their business - the ability to extend free or cheap credit.
"The key issue for LME members, which is distinct from members of other exchanges, is the extent of the credit which they typically extend to their clients," Robert Finney, a partner at law firm Holman Fenwick Willan, which is advising LME members on preparing for the new regulation, said.
Under EMIR, brokers will no longer be able to carry client positions and collateral in the brokers' own account, as they wait for deals to be settled before recovering the credit they extended. They will have separate clearing house accounts.
Under the new rules the client's position and margin will be segregated on the one side and on the other side the broker will have a debit balance to the client. This means increased collateral will be needed from each client.
"The margin and collateral requirements are going to be more rigorous under EMIR and that's going to be a big increase in costs," Finney said.
"But when it comes down to credit, that's not just a cost issue, it's a question of how can credit continue to be extended. And the LME members that aren't banks may also have difficulty accessing other sources to extend credit to clients."