(The opinions expressed here are those of the author, a columnist for Reuters)
LONDON, Aug 4 (Reuters) - There will be few tears shed for Metro International Trade Services.
The warehousing company has just been hit with a $10 million fine by the London Metal Exchange (LME) for its role in abetting the original load-out queue for aluminium in Detroit.
The subsequent splintering of the aluminium price between LME basis price and physical market premium caused collective outrage among manufacturers struggling to find ways to hedge the latter’s unprecedented volatility.
Some are still pursuing Metro and its erstwhile owner, Goldman Sachs, through the U.S. courts.
That may be the reason why technically the $10-million charge isn’t a fine at all, but rather an agreed “settlement” with Metro neither admitting nor denying any of the “alleged breaches or the matters that formed part of the (exchange’s) investigation or the disciplinary proceedings.”
But the legal circumlocution may also reflect a high degree of ambiguity as to whether Metro actually broke any LME rules when it got creative with its queue management system back in 2010.
The charge sheet, as summarised in a July 29 LME notice to members titled “Disciplinary Action: Metro”, doesn’t specify which rules were breached, highly unusually for such an exchange statement.
Rather, Metro seems to be accused primarily of causing “adverse publicity and scrutiny” and impacting “the ability of the LME to perform its function effectively”, at least “in the view of the LME” itself.
As such, the true purpose of this “settlement” appears to be to raise the bar on LME warehousers’ future behaviour, all part and parcel of its campaign to draw what was once an ancillary logistical function into the full glare of regulatory oversight.
So what exactly did Metro do to incur a $10 million public punishment?
The LME notice is a little vague, no doubt deliberately so on the advice of its lawyers with one eye on the ongoing legal proceedings in the New York Southern District Court.
It refers to “certain transactions” between September 2010 and April 2013 involving the circular movement of aluminium out of and back into Metro sheds in Detroit.
These were famously dubbed the “merry-go-round” deals by Senator Carl Levin, who quizzed Metro and Goldman Sachs at length in a special subcommittee hearing on Wall Street’s involvement in the commodities business back in 2014.
And thanks to that hearing we have some detail on what exactly was going on back in September 2010 when the load-out queue at Detroit mushroomed from days to months with a single 100,000-tonne cancellation of aluminium.
That was Deutsche Bank snapping up metal for a cash-and-carry financing deal.
When the bank asked Metro for a rent discount, the warehousing company came up with what must have seemed at the time a very clever solution.
Deutsche would get its discount while its metal was queuing for load-out and it would get an even better discount deal for its off-market storage as well.
All it had to do in return was transport the metal to another Metro shed in Detroit and, once its finance deal had expired, re-warrant the metal back into the LME system.
If it did, its transport costs of $42.95 per tonne would be reimbursed when the metal was re-warranted. If it didn’t, it would have to pay Metro a $65 break fee.
It was a template that would be used again and again with other stocks financiers.
It must have seemed like a virtuous circle to Goldman and Metro, which reaped massive profits from its endlessly self-regenerating queue.
But for users of aluminium, it looked like a vicious circle as the ever-lengthening queue fed ever-rising physical premiums, which at the time were unhedgeable.
WALL STREET VS MAIN STREET
Such a warehousing deal wouldn’t be permitted now.
The LME has overhauled its legal contract with its registered logistics companies to prevent exactly the sort of “merry-go-round” deal dissected by that Senate subcommittee.
But the rule-book was different in 2010. Although “exceptional” incentives to warrant metal were liable to exchange investigation, no-one had actually worked out what sort of incentive would qualify as being “exceptional”.
There was even uncertainty as to what counted as a bona-fide “delivery out”, other than that the metal should physically leave the warehouse in which it had been stored.
In communications with the Levin enquiry, the LME conceded that “on a hypothetical basis”, the sort of circular deal devised by Metro would be “inconsistent with the ‘spirit’” of its rules but might not “violate the ‘letter’ of them”.
Such ambiguity arose from the fact that the LME system simply wasn’t designed to handle the financialisation of the aluminium market that followed the Global Financial Crisis (GFC) of 2008-2009.
LME warehousing rules were written for manufacturers who might need at most a couple of thousand tonnes as a “last resort”, not for banks like Deutsche who wanted hundreds of thousands of tonnes to lock into a financing deal that would generate a fixed rate of return in a world of zero interest rates.
Metro was the flash-point for this unequal tug of war between Wall Street and Main Street, only because Detroit was the obvious destination for many of North America’s smelters when demand collapsed in the wake of the GFC.
To what extent that exonerates Metro’s subsequent exploitation of its good locational fortune and of the gaps in the LME rule-book will depend on where you sit in the aluminium supply chain.
The whole queue saga was viewed, and still is viewed, very differently by producers and end-users.
What is not in doubt, however, is that the LME has put down another marker as to what it now expects of its warehouse operators.
In May 2015 another warehouse operator, CWT Commodities, got hit with a 100,000 pounds ($149,000) fine for failing to identify companies within its group that were deemed metals trading entities.
It seemed a high penalty for what was merely a lack of awareness of its own corporate structure. There was no suggestion that any inappropriate activity or tangible conflict of interest had occurred.
Now Metro has been hit for a much larger sum, the highest ever levied against a warehouse operator, even though it doesn’t appear to have broken any LME rule as existed at the time.
The question is, who will be next and what sort of draconian punishment should they expect if they have?
Editing by David Evans
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