LONDON (Reuters) - Volumes are falling. Discontent is rising. Even the London Metal Exchange’s (LME) new building in Finsbury Square was a let-down.
The LME ring, one of the last surviving relics of open outcry trading, was temporarily banished to Chelmsford, east of London, due to a “structural issue” in its new home.
It has, it’s fair to say, not been a great year for the venerable old dame of metals trading or for its Hong Kong owners.
It remains to be seen what reception LME chief executive Garry Jones gets when he addresses a black tie dinner on Tuesday, the centerpiece of the annual get-together of the global metals trading community. Frosty might be as good as it gets.
Among the audience will be a smattering of brokers who are so unhappy with the direction of travel they have asked former LME executive Martin Abbott to study the potential for a new metals trading platform.
The last hurrah of the old boys club or a new challenge to the LME’s still dominant but fraying franchise as setter of global benchmarks for industrial metals pricing?
That remains to be seen but it is a symptom of the general unhappiness simmering in the tight-knit LME brokerage community.
Expect the LME itself to talk of a brighter future, a gilded path into the world of bullion trading early next year followed by a roll-out of more products in the wake of this year’s steel scrap and rebar contracts.
But the LME still needs to stop a creeping rot in its core offering if it is to fend off an increasingly aggressive challenge from transatlantic competitor CME Group.
Some of the discontent among the LME fraternity is down to bigger forces.
The metals markets are still reeling from the bursting of the commodities supercycle bubble. It’s no coincidence that the last time LME volumes slumped this badly was back in 2001, another year of collective hangover after the dot-com party.
The nature of trading is itself changing. The flash boys and their algos now light up LME screens, playing virtual spoof with each other across the three-month contracts.
The old brokerage model has become ever more concentrated in the trading of spreads. The LME’s multiple prompt date system is still sufficiently weird and wonderful to withstand the predatory robots.
The LME itself, however, has played a part in its own misfortune.
Everyone knew that trading fees were going to go up after the initial stand-still promised by Hong Kong Exchanges and Clearing following its purchase of the LME in 2012.
But even exchange insiders will admit, albeit privately, that the hikes on the short-dated carries, the heart of LME spread trading, were a mistake.
Trading in “tom-next”, the spread between tomorrow and the day after, has been hit far harder than the headline figures suggest.
The LME’s reversal of fee hikes on such spreads, the life-blood both of brokers and industrial users, was a case of too little too late for some.
Meanwhile, its attempt to attract more liquidity by opening up membership to new players and facilitating electronic trading between the rolling three-month price and other spreads has served only to antagonize further.
The first company to pick up the carrot of LME membership was Jump Trading Futures, a Chicago outfit which describes itself as having been “at the forefront of algorithmic trading since its founding 15 years ago”.
Exactly the sort of player feared by LME traditionalists and the industrial supply-chain users who lend LME pricing its real-world credibility.
The headline fall in trading volumes was 9.6 percent in the first nine months of this year, not quite as bad as the near 11-percent collapse in 2001.
But 2001 was something of a one-off. The recent decline in activity has been running for four years and this looks set to be the second consecutive year of falling volumes.
Moreover, some contracts have been hit harder than others. Cobalt trading has slumped by 63 percent, aluminum alloy by 46 percent and North American alloy by 40 percent.
The molybdenum contract has quietly given up the ghost and died. The last activity was in June and any remaining stocks have departed LME warehouses.
Now, none of these “lesser” contracts was ever going to set the world on fire. You don’t read a lot of front-page stories about molybdenum.
But they are all products tailored specifically for industrial rather than financial users, the bricks and mortar on which the LME’s credibility rests.
Is their precipitous decline a warning of the risks of pursuing liquidity from proprietary electronic traders at the expense of the market’s industrial user backbone? There are many who believe so.
What can the LME do to reverse the slide in volumes?
The two new steel contracts offer a potential way forward. It’s still early days and the memory of the failed billet contract lingers, but the scrap contract in particular is showing healthy signs of traction.
LME executives are running the rule over other potential new contracts such as ferro-chrome, the sort of specialist metal that reburnishes the exchange’s industrial credentials.
The only problem is that these new steel contracts are plain vanilla monthly futures contracts with no daily spreads and no physical delivery. So too will be the next generation of contracts to follow.
The same sort of contracts, in other words, offered by every other big exchange, particularly the CME, which has been rolling out new metallic products with increasing regularity. The most recent, it is worth noting, is a North American aluminum alloy contract.
It’s the LME’s labyrinthine spreads, which evolved from industry’s need to roll and adjust positions across odd dates, that has been its unique selling point for so many years.
If it loses that differentiator, how well equipped is it to resist the incursions of CME or, further down the line, from Chinese exchanges such as the Shanghai Futures Exchange.
And at the center of this unique date system sit a handful of dealers in a ring of red leather seats.
The ring was displaced briefly in August by those “structural” problems in the LME’s new offices.
The fear among parts of the broking community is that it will be displaced permanently by a different sort of structural problem.
As for the LME, it has the unenviable challenge of squaring its need to evolve and boost flagging volumes with the circle that sits at its very heart.
(The opinions expressed here are those of the author, a columnist for Reuters)
Editing by Jon Boyle