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25 July 2019

The London Metal Exchange (LME) is today launching a consultation process on a package of proposed measures designed to ensure that the LME warehousing network continues to provide best practice storage for the global metals industry.

The LME’s proposals have been informed by the 46 responses to its discussion paper, which focused particularly on the underlying use-case for LME warehousing. While it remains the case that current stock levels are fully able to fulfil the requirements of physical delivery on the Exchange, respondents generally agree that higher LME stock levels could achieve market-wide positive effects, including greater transparency, potential protection against technical spread tightness, and increased market vibrancy.

Given this broad view, the LME accepts that an aim of its warehousing policy should be to create an environment of sufficient stock levels in order to achieve these positive effects for the whole market. As such, the proposals put forward combine the most effective routes to deliver this aim, using both logistical and financial drivers. The proposals are grouped into three areas: logistical optimisation; transparency and compliance; and rebalanced rules and a pathway to simplification.

Matthew Chamberlain, LME CEO commented: “There is general market agreement that higher LME stocks would be desirable, but two opposing views on how to achieve this. The LME understands the perspective of those who seek lower rents and enhanced logistics from LME-listed warehouses – and while we are introducing many logistical enhancements in this consultation, we believe that fundamentally reforming the LME network in an attempt to compete with highly discounted off-warrant storage may fail, and indeed result in reduced stock levels.

“On the other hand, the LME understands that many warehouse operators feel that they could bring more metal to the system if rules were relaxed – and while we wish to support our warehouses’ businesses, this must be balanced with the need for robust consumer protection. Our proposed package of measures is therefore designed to bring together the best elements of these various approaches.”

Logistical optimisation

Proposals in this area aim to make the LME network easier to use for the metals industry, particularly for consumers. Proposals include the introduction of restrictions on so-called “evergreen rent deals” (arrangements whereby metal owners retain an interest in warehouse rent on warrants which they have previously sold) that will only allow warehouse companies to enter into such an agreement with the party placing metal onto LME warrant (and not with metal owners who have purchased metal that is already warranted). This proposal is designed to allow incentivisation for metal owners bringing new stock to the LME system, while reducing the incidence of existing warrants being acquired on the LME purely for the purpose of extracting evergreen rent deals from warehouse operators.

The LME also proposes to extend of the current freeze on maximum levels of rent and FOT until 2027-28, to ensure that the gap between headline rates for LME storage and storage rates for off-warrant or bilaterally negotiated LME storage does not widen further.

Transparency and compliance

This topic aims to achieve increased transparency of global metals stocks, as well as an enhancement of the LME’s powers to protect users from warehouse insolvencies. The LME will also provide greater granularity of warehouses’ cancelled warrant data, once the necessary systems changes have been introduced.

Bringing greater transparency to non-LME stock reporting was met with mixed views by discussion paper respondents, but the LME considers that the market benefits of increased stock transparency outweigh arguments regarding the right to maintain confidentiality over metal stored off-warrant. However, in order to avoid potentially disadvantaging LME-registered warehouses and incentivising avoidance strategies, the LME will not proceed with its “eligible stocks” proposal put forward in the discussion paper.

Instead the LME proposes to introduce a stocks reporting process that reflects the fact that many metal owners choose off-warrant storage, but with the knowledge that metal can be warranted if ever required. Such metal owners benefit, in the view of the LME, from the option of LME warranting and should, therefore, be willing to contribute to off-warrant stock reporting. As such, the LME is proposing a set of rules which will create requirements and incentives for off-warrant metal to be reported to the LME, if metal owners may wish to warrant such metal at a future point in time. The LME will assess the data thus gathered – and, if it believes the information to meaningfully aid transparency, will publish data to the market on an anonymised basis.

Rebalanced rules and a pathway to simplification

The LME is mindful of the desire among many warehouse operators to relax and simplify its load-out related rules, which would provide scope for a greater financial incentive for the warranting of stocks. However, the LME remains determined that any changes should not disadvantage consumers, particularly in allowing unacceptably long queues to form. The Exchange therefore proposes to first make progressive changes to its Queue-Based Rent Capping (QBRC) and Linked Load-In / Load-Out (LILO) rules, as a first step in the pathway to rebalanced rules supporting warehouses to bring stock to the LME system, and ultimately to rule simplification.

The QBRC threshold will be extended from 50 days to 80 days over a nine-month period, and the phased element of rent reduction will also be removed (rent obligations currently drop 50% after 30 days). By phasing in the extension, the LME would be able to assess the impact of the rule change as it progresses, reserving the right to stop the implementation should it cause disruption to the market (including attempts by warehouse operators to take advantage of the rule changes to incentivise the formation of structural queues). In choosing an 80-day cap, the LME has also been mindful of ensuring that warehouse incentives should not rise above physical market premiums, to prevent warehouses competing with the physical market for metal demand.

In respect of LILO, the LME proposes to amend some elements of the rule in order to offer greater clarity as to its application, and protect warehouses in the situation that a queue emerges unexpectedly.

If the changes to QBRC and LILO prove successful, then the LME will consider a future simplification of its rules, transitioning from these rules to a logistically simpler “percentage load-out” model, whereby warehouses would simply be required to load out a given proportion of their stock each day. This would provide the same economic protections for metal owners as the modified QBRC and LILO rules, while making the LME ruleset significantly easier for market users to understand and apply.

The consultation is open until 12 September 2019 and the LME welcomes responses from all market participants and other interested parties, including regulatory and governmental bodies.