The Heavy Metal Battle Between JPMorgan and This Historic Exchange

  • LME is planning new fee charging dealers for OTC contracts
  • JPMorgan is one of the biggest OTC metals traders in London
Traders react on the trading floor of the open outcry pit at the London Metal Exchange Ltd. (LME), in London, U.K., on Monday, April 10, 2017. Iron ore's descent into bear-market territory may herald further weakness, with Barclays Plc pinning the blame for the slide on lower steel demand in China driving a shift from mills toward lower-quality ore and raising the prospect of a drop into the $50s. Photographer: Simon Dawson/Bloomberg

In its battle to restore its place in the market, the London Metal Exchange is taking aim at one of its largest customers: JPMorgan Chase & Co.

JPMorgan has a leading over-the-counter metals trading operation, where buyers and sellers deal in private contracts outside the exchange. It will be most affected by an LME plan to charge dealers a fee for using exchange prices for OTC trades, according to people familiar with the matter.

After two years of declining trading activity, the LME is targeting the OTC market in the belief that banks and brokerages have helped siphon business away from the exchange. The new fee, which could come into effect next year, represents the more aggressive part of Chief Executive Officer Matthew Chamberlain’s strategy to revive the fortunes of the bourse.

The LME is trying to wring more profits from trading as part of a broader shift to becoming a money-making company. Before the exchange’s $2.2 billion takeover by Hong Kong Exchanges & Clearing Ltd. in 2012, it was run for the benefit of its members, who were also its shareholders — the largest of them JPMorgan.

In the years after the takeover, the LME faced a blacklash from traders complaining about higher fees and Chamberlain, who took the top job at the exchange this year, worked quickly to reduce costs and repair relations with members. However, the new fee on OTC trading is the most controversial element of Chamberlain’s new plan and depending on how JPMorgan decides to react, could plunge the exchange into a fresh dispute.

The LME’s internal estimates show the new fee could bring in $10 million a year in extra revenue, according to a person familiar, who asked not to be identified because the discussions are private. That’s based on the assumption that about 20 million lots a year trade in the OTC market. About half would be subject to exemptions from the new fee, which the LME has indicated could be set at $1 per lot.

Member Review

The new fee will be put to a formal consultation among exchange members in mid-November.

JPMorgan will likely pay the highest fee among traders, although it is likely to be less than half of the $10 million, the people said. They cautioned the numbers are only estimates because there is no data on the size of the OTC market.

Still, even at that level, it’s a small dent in JPMorgan’s overall commodities business. A spokesman for JPMorgan declined to comment.

At the heart of the issue is a disparity in the LME’s fee structure. Members who trade LME-like contracts with their clients over the counter pay only a third of the fees compared with those trading essentially the same contracts on the exchange.

In an interview on Friday, Chamberlain said that the idea of a new fee for OTC trades had received “broad-based support” from the members.

‘Isn’t Fair’

“There are many members who feel it addresses a competitive disadvantage under which they’ve been operating,” Chamberlain said. “Although they’re not there to look out for the LME, I think they get the concept that it probably isn’t fair.”

Other banks and brokers with significant OTC businesses, who are also likely to be affected by the new fee, include Goldman Sachs Group Inc., Societe Generale SA, Triland Metals Ltd. and Marex Spectron Group Ltd. Always a feature of metals trading, the OTC market has grown in recent years in part because traders sought to avoid the sharp increases in the LME’s trading fees.

In the past few years, JPMorgan pushed many clients to shift trading to the OTC market from the LME, according to people familiar with the matter. That was in part driven by regulatory concerns and predated the LME’s fee hike, one of the people said.

OTC Trading

“Some of our members do have a more OTC-focused business model,” Chamberlain said. “We absolutely accept that that hasn’t been done by any means for fee avoidance, probably it’s been done at the request of clients to go down that route.”

Francois Combes, head of metals at Societe Generale, said at an LME Week panel on Monday that the new fee could be welcomed by the market.

"If there is a battle, it will focus on where there is systematic fee avoidance on an industrial scale that kind of distorts the market," he said. "I expect the market will welcome something that can solve this."

For JPMorgan, the new fee is likely a blow, but a minor one. The bank was the third-largest in commodities in the first half of 2017, according to Coalition Development Ltd., a London-based analytics company. It made about $800 million to $900 million in net revenues from commodities last year, according to people familiar with the matter.

Chamberlain said he was ready to listen to members’ concerns about the new fee. The exchange could offer discounts for shorter-dated carry trades, much like it has done for on-exchange contracts, and would consider imposing the fee later than January, as initially planned, to give members time to prepare for the change.

“If anyone feels we’re acting unfairly or in a way that disadvantages certain groups, there will be a very fair and open process to raise those concerns,” he said.

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