(The opinions expressed here are those of the author, a columnist for Reuters.)
By Andy Home
LONDON, May 2 (Reuters) - The London Metal Exchange (LME) is planning to start publishing a commitments of traders report (COTR) from July.
This, the LME said in a notice to its members, is in response to “a general market demand for broader transparency”.
The need for more transparency was in fact the only point of agreement in the polarised argument over what to do about the long load-out queues at LME warehouses.
U.S. aluminium producer Alcoa, for example, rejected any need to cut queue length but contended that “today’s antiquated reporting structure of the LME is not providing the pricing transparency by differentiating between fast money investors and those that are interested in physical metal supply, raising questions about the validity of the price determination.”
Aluminum fabricators, who called for the LME to slash the load-out queues, agreed that “it is necessary to improve transparency at the exchange”. Even Goldman Sachs, owner of LME warehouser Metro, which was behind the original Detroit load-out queue, joined its voice to the chorus for more transparency.
And what’s to disagree about? Greater transparency in any market is obviously a positive.
It’s just a shame that the proposed commitments of traders report, designed to mirror that published in the U.S. by the Commodity Futures Trading Commission (CFTC), won’t help.
Indeed, it may actually hinder the quest for more transparency by presenting a distorted picture of the LME market, as the exchange itself admits.
There are two problems with a COTR for the LME, one generic and one specific to the metals market.
The CFTC reports are severely constrained by the regulator’s legal requirement to preserve the confidentiality of individual traders.
Historically, therefore, it aggregated large positions into two main categories; commercial traders, the market’s good guys, and non-commercial traders, the much-maligned “speculators”. The remaining small positions were lumped into a “non-reportable” category.
Commodity markets, however, evolved in ways that defied such a binary view of the trading world.
So the CFTC launched a revamped disaggregated report in 2009 with new categories; “producer/merchant/processor/user”, “swap dealers”, “managed money” and “other reportables”.
The LME will in essence borrow this template, albeit with “swap dealers” renamed as “broker dealer/index trader”.
The underlying problem, though, remains the same, namely the fact that the reports classify traders rather than positions.
As my colleague John Kemp wrote some time back (“Inside the Commitment of Traders Report”, May 9, 2012), a major oil company will be classified under just one of the categories, even though its positions might be a mix of hedging and speculative positioning.
There are many such examples in the world of base metals trading, entities such as Glencore and Trafigura defying easy categorisation.
The problem is compounded by the fact that the CFTC can’t for confidentiality reasons tell anyone how individual companies have been classified.
The reports, therefore, offer only a partial and potentially misleading picture of actual positioning at any one time, amplified by the fact that there is no other data-set for analytical comparison.
The LME itself concedes such intrinsic flaws.
“The market is asked to note that the COTR will be materially affected by the classification of certain large market users, whose activities arguably fall into multiple categories.”
Then, there are specific problems with the nature of the LME market, which overlays a much larger over-the-counter market-place.
Order flows are often netted off against each before hitting the LME.
As the exchange also concedes, this will “inevitably result in the published COTR data reflecting only a subset of the total activity conducted within the LME ecosystem.”
Imagine, for example, a bank member of the LME receiving a buy and a sell order from a producer and manufacturer respectively. It will offset the two and hedge only the net balance position in the market. If it does that with another bank, it will look like a bank-to-bank “financial” transaction with no reference to the industrial origins of the order.
There is a real danger that what the LME calls the resulting “subset” of activity will overweight “financial” as opposed to “industrial” position-taking.
This has been a major restraint on the LME going down the COTR route in the past.
Indeed, the LME in its public consultation document on its warehousing problems rather pointedly noted the “potentially cynical rationale” behind the push for a COTR.
“It is interesting to note that merchants, investment banks and funds will feature prominently in any market open interest reporting.”
“Both producers and consumers (whose views on the proposal are otherwise strongly divergent) feel that this information would be strategically useful, as it will allow them to point to the role of ‘middle-men’ and speculators in the market as an explanation to their stakeholders for price movements which have adversely affected their businesses.”
It even conceded that “the information will undoubtedly be used by market participants to level further criticism at the LME” for allowing too much “speculation”.
But it’s going to publish a COTR anyway.
It’s an easy box-ticking exercise to assuage an industrial user base that feels increasingly disenfranchised by the financialisation of “its” market, a simmering resentment that was brought to a head by the problem of queues, caused in major part by financial players involved in the stocks financing trade.
And to be fair to the LME, a COTR is only one of several proposals to shed more light on the nature of the exchange’s activity. It will, for example, also be publishing a monthly report showing warehouse stocks by operator, rather than simply by location, and detailing load-out queuing times at affected locations.
And transparency, we’re all agreed, is, in capital letters, A Very Good Thing.
Just don’t expect too much of it from the proposed LME commitment of traders report. (Editing by William Hardy)