CME challenges LME in its metals trading heartland

When Hong Kong Exchanges and Clearing (HKEx) bought the venerable old London Metal Exchange (LME) back in 2012, it did so with eyes firmly fixed on China. The vision was to leverage the LME’s near monopoly on base metals pricing in the rest of the world to open up the world’s fastest-growing metals market. That remains the vision, although HKEx’ ambitions in the commodities space have taken back seat to its Stock-Connect bridge between Hong Kong and mainland Chinese stock markets. What HKEx almost certainly wasn’t expecting back in 2012 was a challenge to the LME’s existing franchise outside of China. But U.S. exchange CME has other ideas. It has just announced its fourth new base metals contract and with the latest, a European aluminium premium contract, it is taking the battle into the LME’s historic heartland. Premium opportunity There will be many on the LME “Street” that greet CME’s latest product launch with a knowing smile or a shrug of the shoulders. After all, up to now CME has struggled to extend its industrial metals portfolio beyond copper, a metal in which its COMEX division has deep roots in the North American market-place. Everyone remembers the COMEX aluminium contract of the noughties, an ultimately doomed attempt to challenge the LME’s dominance in aluminium trading. But one of CME’s more recent forays beyond copper does genuinely appear to be gaining traction. Its U.S. aluminium premium contract, indexed against Platts’ assessment of the Midwest market, has this year seen both volumes and open interest accelerate. The fact that they have done so even while physical premiums have collapsed should give LME supporters pause for thought. When the contract was launched in 2012, it looked like an opportunistic bid to capitalise on the LME’s problems with its North American manufacturing user base. Relations had almost reached breaking point on the vexed issue of aluminium load-out queues from some LME warehouse locations, particularly Detroit, and the resulting perceived impact on physical premiums. Premiums were going stratospheric, widening the disconnect between hedgeable LME basis price and “all-in” price, the latter including a then non-hedgeable premium component. As is often the way with such things, it took a long while for the CME premium contract to build any momentum. In December last year trading volumes were just 947 lots and open interest just 5,431 lots. Then premiums imploded early this year. The CME front-month Midwest premium collapsed from 24.12 cents per lb at the end of January to 8.39 cents at the end of June, not least because the LME had announced a series of ever more stringent warehousing rules, in effect killing off the queue model. Not entirely surprisingly, that premium slump was a shot in the arm for the CME premium contract. More surprising, though, is the fact that the subsequent stabilisation of the premium, currently trading at 7.19 cents per pound, has been accompanied by still rising volumes and open interest. Volumes in August were 4,555 lots, bringing the year-to-date total to 25,787 lots. Open interest reached a new record high of 19,335 lots, or 483,375 tonnes, at the end of the month. Premium competition So you can see why CME is now looking to replicate that success in Europe, this time linking its product to Metal Bulletin’s assessment of the European duty-unpaid premium. It is also stealing a march on the LME, which has itself committed to four new aluminium premium contracts, aimed at exactly the same disgruntled user base as those of CME. The LME contracts, one for the U.S., one for Europe, one for East Asia and one for South-Eastern Asia, are only scheduled to go live on November 23. The CME’s version will start trading on Sept 21. The key difference between the two is the fact that while CME’s are cash-settled, the LME’s are physically settled, allowing delivery of metal in locations without queues, which really means all but two, Detroit and the Dutch port of Vlissingen. To be fair to the LME, the exchange would probably have liked to launch its premium contracts a lot sooner but got bogged down in a legal challenge from Russian producer RUSAL over its proposed solution to killing off the queues, a prerequisite for formulating the physical delivery options for the premium contracts. But the long and the short of it is that by the end of this year European aluminium players will have two premium contracts to trade. Heartland Moreover, the CME’s latest proposition is symbolically significant. It is taking its competition with the LME into the latter’s heartland. If European manufacturers and producers hedge at all, they are likely to be doing so on the LME, with its multiple good delivery points scattered across the region. It is an open secret that the only entities to vote against the HKEx purchase of the LME were German industrial users, who liked the LME just the way it was. But CME has already thrown down a marker of its ambitions to grab a larger slice of the metals trading pie with both its physically-delivered “all-in” aluminium contract, launched last year, and a new zinc contract, launched in June 2015. The former is still struggling to build momentum with open interest last month of just 122 lots although low usage does not mean no usage. Those volume and open interest figures only tell half the story. Stock movements tell the other half. CME aluminium warehouses have taken in 29,500 tonnes and loaded out 15,400 tonnes of metal so far this year. Even that sort of delivery activity, of course, is dwarfed by that on the LME and many sceptics will hear the echo from that failed COMEX aluminium contract. Unless that is, CME is able to tap a new seam of potential users, those who either haven’t ever used the LME or those who would like to but are too small to clear the high credit bar for opening an LME account. That might be one reason for the U.S. premium contract’s relative success, given a large number of smaller manufacturers in the Midwest who have never hedged their aluminium exposure before and were unlikely to do so on the LME. Which raises the interesting question of whether there are similar players in the European region who might be drawn to the CME’s more vanilla trading model. Time, as they say, will tell. For now the LME still enjoys a near monopoly on pricing outside of China, barring North American copper. What’s changed, though, is the fact that monopoly is no longer undisputed.