LME Warehouse Backlogs Seen by Euromin Being Challenged on Banks

It’s only a matter of time before the long waits for metal at warehouses monitored by the London Metal Exchange are challenged because of increased regulatory focus on banks, according to Mike Baker, risk manager at Euromin SA, the metals trading company owned by London-based Vitol Group.

The following comments are from a copy of Baker’s speech that he made at Metal Bulletin’s 17th Annual Zinc & Its Markets Seminar 2013 in Amsterdam on May 7.

“There is nothing illegal in ‘formation’ of these queues. However, at a time when the behavior of banks and large trading companies is under increasingly close scrutiny from the regulatory authorities, it is only a matter of time before the situation is challenged.”

At the conference, Diarmuid O’Hegarty, chief operating officer of the LME, said the LME has no control over who owns warehouse companies.

“The new warehouse owners bought into the warehousing business because they saw a profit opportunity, and a very good one at that. There is currently around $3.75 million of LME rent to be earned every single day. The question became, how could a warehouse acquire a significant part of this income in the most efficient manner?

‘‘If the minimum load-out rate mandated by the LME was to be interpreted as a maximum load-out rate by the warehouses, they realized that a sufficiently large queue of canceled warrants would effectively create a dam against the delivery of material from warrant. Just like a water dam, the warehouse dam would allow a trickle of metal out, but the reservoir of material behind the dam could be replenished and increased by the delivery of further material into warehouse.’’

‘‘Although none of what the warehouses are doing is illegal the issue of LME warehousing is getting ever greater scrutiny from regulatory authorities, particularly in the U.S.

‘‘If the users of the market continue to shy away from this issue and remain quiet then we as an industry are unlikely to see any changes any time soon, and indeed the situation is only likely to get worse.’’

‘‘The queue acts as a deterrent and lessens any demand for material from that warehouse.

‘‘Participants cannot generally afford the cost of both rent and finance incurred by waiting an extended period in order to access material. Therefore they invariably do not even try to get material from a warehouse where a queue exists.’’

‘‘Queues are caused by participants wanting to remove material from store, whilst the very structure of a rent deal meant that the material was tied up and not available to the market, and consequently not available for delivery out of the warehouse. This is corroborated by the fact that these ’rent deals’ have existed for many years and certainly predate the existence of warehouse queues.’’

‘‘The first sign of a blurring of the boundaries between the warehouse and the trader occurred when the warehouses started arranging these deals for themselves, and began paying premiums to entice material into their warehouses. The limitation of the rent deal was that it required access to an adequate supply of cheap money, and contangos sufficiently large to offer a reasonable return. Both have been readily available in recent years.’’

‘‘The mindset of the warehouse companies is epitomized by their interpretation of minimum load out rates set down by the LME, as maximum load out rates for the warehouses.

‘‘If the load-out rates were set per warehouse facility rather than per company the bottlenecks would be likely to ease and could even disappear as the cost of maintaining a dam on each warehouse facility would be prohibitive compared to the potential profit to be gained.’’

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