LONDON (Reuters) - Attempts by European regulators to increase transparency on the London Metal Exchange face opposition from traders, but the LME must comply and is offering a new trading system among other options in an effort to assuage concerns.
Trading on the world’s oldest and largest metals exchange has to adhere to the Markets in Financial Instruments Directive II, which came into force in January 2018, with one requirement being that all price quotes and trades are known to the market.
Most trade on the LME is transparent, while waivers granted by Britain’s Financial Conduct Authority were applied to those that were not. The European Securities and Markets Authority (ESMA) now wants those waivers removed.
Telephone trading is captured by LME systems when conducted on the floor. The problem is that not all telephone trade is carried out on the floor.
Trades under scrutiny from the European Union regulator are those transacted on the LME telephone market, as bids and offers - information known as “pre-trade” - are not published until deals are executed.
“The LME has no choice, it has to find a way to make ‘pre-trade’ transparent,” a senior metal trading source said. “Brokers can protest, but the exchange has to comply.”
In a consultation that ended on March 1, the LME said it could build a platform that would make “pre-trade” transparent. LME brokers are opposed, however, saying such a platform could pressure their revenues.
Brokers are concerned that customers might take their business elsewhere if a new, transparent system leads the LME to prevent certain trades because they fail to meet requirements.
Clients could decide to trade directly on Select, the LME’s electronic trading system, or use the over-the-counter market instead, brokers say.
“This doesn’t work for our market, where anonymity is king,” a source said.
MiFID regulation aims to improve transparency and curb excessive speculation by forcing as much trade on exchange as possible. Exemptions are available for companies that produce or consume commodities as part of their normal business.
A broking source said the LME must convince ESMA that activity is hedging-related and use the waiver. The hedging waiver is applicable to physical market customers such as consumers and producers to manage price risk.
The LME, owned by Hong Kong Exchanges and Clearing Ltd, declined to comment.
A new platform that displays bids and offers would help many users who rely on the telephone market to trade small amounts or contracts that are illiquid.
ESMA has a “large in scale” waiver that allows big trades to be exempt from “pre-trade” transparency. The LME’s consultation paper said 7 percent of its market volumes would not be covered by this exemption.
Some customers worry brokers will raise commission rates if their margins are squeezed, a source at a trading house said.
One source said the new platform being considered would require buyers and sellers to put “pre-trade” orders into a system visible to all brokers.
The disadvantages of building a new system include additional rules for members, higher costs for the LME, and concerns that it could paint a misleading picture of liquidity and pricing, the LME said in the paper.
Other options including limiting the threshold on the telephone market by banning smaller trades were not supported by members, a source said.
The application of pre-trade requirements would depend on the outcome of Brexit negotiations.
The LME said it would be expected to comply with the pre-trade transparency requirements whether there were a “hard Brexit” or not.
Reporting by Zandi Shabalala; editing by Pratima Desai and Dale Hudson