LME favours new pricing mechanism to boost monthly trading

LONDON (Reuters) - The London Metal Exchange wants to attract funds and reverse falling volumes by boosting liquidity on monthly settled contracts using prices from trading on other dates, Matt Chamberlain, the LME’s new chief executive, told Reuters.

Men walk past the London Metal Exchange (LME) in London, July 22, 2011. REUTERS/Paul Hackett/File Photo

The LME is under pressure to build volumes after they fell 7.7 percent last year and 4.3 percent in 2015.

The exchange is proposing a process called implied pricing that would extrapolate prices for contracts that mature on the third Wednesday of each month from trading activity on its most liquid three month date.

The mechanism would generate an artificial price from bids on a three-month date and carry trades that connect them to a third Wednesday. It could also extrapolate prices for three-month contracts from activity on third Wednesdays, allowing liquidity on each date to be mutually reinforcing.

Chamberlain, who was appointed on April 21, said the idea had the support of members and traders.

“Implied pricing is the easiest way to go,” he said on Tuesday. “That is likely to be the most sensitive way of moving the market to where we think it needs to be.”

The implied pricing idea is one of four proposals in a discussion paper published on Monday to boost trading of contracts which settle on the third Wednesday of each month.

Chamberlain is hoping the “third Wednesday” contracts, which are closer to the standardised monthly futures of other exchanges, will attract fund investors. But traditional members fear liquidity on three-month contracts could fall, undermining the exchange’s position as global benchmark setter.

The other proposals in the discussion paper are incentives to trade on third Wednesdays, to introduce a separate monthly futures contract and for members who trade over-the-counter (OTC) with clients to publish their volumes and prices for third Wednesday dates on the LME.

All four options are on the table until the deadline for feedback on the discussion paper ends on June 30.

But Chamberlain said promoting a futures contract would risk splitting liquidity and that implied pricing would make the reintroduction of incentives unnecessary.

He said the OTC option would create a parallel market on the LME’s system, which the exchange would prefer to avoid.

Funds also want the LME to allow investors to settle trades as soon as they are closed, enabling them to immediately realise profits and losses. They can do this on other exchanges such as the CME CME.O, but not with the LME's monthly contracts.

Chamberlain is aiming to make the change but only after putting in place measures to protect industrial users who benefit from financing from their brokers under current rules.

Those measures could take a year to put in place, he said.

“To do it straight away might impact some of our core physical market stakeholders.”

Reporting by Peter Hobson; Editing by Pratima Desai and David Evans