London Metals Hub Buckles as China and U.S. Turn Up the Heatby and
Trading drop eroding dominance of LME among global exchanges
Market share hurt by commodity slump, higher fees, new rules
Traders are buying and selling more metal than they have in years on Chinese and American exchanges. In London, the heart of the global market for more than century, it’s just the opposite.
During the first four months of the year, futures trading on the London Metal Exchange fell a combined 10 percent for its six main contracts, including copper and aluminum. That’s the worst start to a year since the data begins in 2006. While the LME remains the industry’s primary hub, its share of the global market slipped to 76 percent last year from 83 percent in 2012, according to the exchange.
At a time when the commodity rout and regulatory hurdles have forced banks and hedge funds to exit the market, the LME is seeing less trading after raising fees and tightening rules at more than 600 warehouses. But business is booming in China, where the Shanghai and Dalian exchanges benefited from a speculative surge in raw materials, and in New York, as copper trading on the Comex reached a three-year high last month.
"It’s a challenging landscape,” said Robin Bhar, an analyst at Societe Generale SA in London. “If you look at what the LME has been doing for its warehouse reforms and its trading, there’s been a lot of changes, which may have resulted in declining volume.”
Fewer transactions are a setback for the LME, which had sought to lure more business through high-frequency and algorithmic trading. Last year, the exchange proposed offering discounts for companies that trade a lot of contracts, expanded access to its electronic platform and relaxed application procedures for new members.
LME copper trading in April slid 6.8 percent from a year earlier, compared with a 29 percent increase on the Comex and 25 percent in Shanghai, exchange data show.
Since buying the LME in 2012, Hong Kong Exchanges & Clearing Ltd. has sought to boost profit from the 139-year-old bourse. Fees charged to members and users rose an average of 34 percent last year, the first increase since the takeover. That helped HKEx increase profit from commodities by 68 percent in 2015, even though volumes had started to dry up.
This year, fees have stayed steady as trading shrinks even further.
“It’s not easy for them to further grow LME’s profit in the near term,” said Edmond Law, a Hong Kong-based analyst with UOB-Kay Hian Holdings Ltd. “They’ve already done the fee hike, so in the near term, volume will be weak and they’re not going to raise prices again. So on that part, earnings will be just flat or declining."
Kathy Alys, a spokeswoman for the LME, said volumes naturally fluctuate because of changes in the global economy and the needs of industrial users.
HKEx this month reported a decline in first-quarter earnings, citing “subdued activity” in Hong Kong cash and U.K. commodities markets. The exchange also blamed the trading slump on a weak global economy and depressed raw-material prices.
“LME has declined,” said Fred Demler, global head of LME metals at INTL FCStone Inc. “There’s a lot of thought of why that is. One reason is the fee increase.”
Higher fees discouraged some users, including for short-term spread trades that exploit price differences between two contracts. One such transaction, called tom-next, involves buying metal and selling it a day later. In copper, tom-next trading is down more than 15 percent in 2016 from a year ago, according to data compiled by Bloomberg.
"If you’re going to raise the costs of doing something, there’s a chance you’ll modify the participants’ behavior," Leon Westgate, an analyst at ICBC Standard Bank Plc in London, said by phone. "And that seems to be the case."
There’s also tougher competition. In some cases, it’s cheaper to trade copper on CME Group Inc.’s Comex, according to Demler of FCStone. In copper, more than 2 million contracts changed hands in April, the most since 2013.
In China, speculation in commodities futures led to record trading in everything from steel bars to cotton. A sudden burst on one day in April took the value of futures traded to $261 billion, about the same as the U.S. equity market. The frenzy has since eased as exchanges raised trading fees and shortened hours.
Reforms in the LME’s network of warehouses also dented trading. The exchange has cut down on lengthy wait times to withdraw metal, but that’s also led to smaller stockpiles because traders are removing more metal than what they are putting into warehouses. That, in turn, has curbed the trades that would accompany holding stockpiles.
"Now the queues are under attack, people are taking units out of the LME warehouse and stacking them elsewhere," Westgate said. "You haven’t got that level of short-term hedging and juggling around of physical positions. You’ve got less units in the LME."