It used to be a pretty simple business; you made money from commission, from jobbing – in all its guises - from interest on netted-off margin cash and from a few other little extras, like warrant swaps and so on. For those with strong balance sheets and available cheap cash, warrant financing was also relevant.
Are all those avenues still open? I’m not sure that they are.
On the surface, the ballooning of LME volumes
in the last few years should be good news on the commission front, but that only tells half the story. Parallel with the increase in volume has come an erosion of commission rates, a move which picked up its pace hugely with the arrival of the order-routing systems.
Now, in a quote-driven market, I can fully understand the concept of commission-free trading – you’re choosing the bid-offer spread you’re making, so why should there be a commission added as well, goes the argument. I’ve got a fair amount of sympathy with that approach.
But, by accident or design, the LME is now effectively an order-driven market, with the electronic trading platform providing a very high degree of transparency. But at the same time as the old market-making spread has gone, commission rates have also continued to decline – on the basis that if the customer is doing all the work of entering and monitoring orders on line, why should he also pay a high commission?
Again, I can’t fault the logic, but it surely does create an issue for metals brokers.
In an ideal world, the decrease in commission rates would have been compensated by the increase in volume. I would need to be convinced that that has happened.
What has come out of this, though, is something like the tale I was told recently by a senior executive at a major mining house.
One of his brokers, unhappy at the amount of commission the miner in question was paying him, called a meeting to tell the client that from now on he was going to have to pay a minimum of $25,000 a year to keep the line open.
In reply, my friend simply showed his list of a dozen other banks and brokers, and the credit lines they gave him, and suggested that this probably wasn’t really the way forward.
My friends, this is a “commodity” market, in both senses; asking your client to pay for the same service he gets elsewhere for free is unlikely to be successful.
I have also heard, this one not at first hand but I believe it to be true, of brokers asking for an up-front payment before they will begin working on setting up a line for a client.
Now, I am the first to acknowledge the amount of time and effort required to get through everything required these days – due diligence, know your customer, and so on, but I wonder if this is the best way to adapt to changing circumstances.
The style of jobbing has changed, as well. Whereas in the past, if your account exexs were worth their jobs, they would have a steady feel for what the underlying market participants were thinking and what their intentions might be.
That then helped a competent dealer to set his jobbing book in the right direction. Not foolproof, obviously, but helpful. (Just for the avoidance of doubt, I’m not talking about front-running here. I’m talking about using the resources at your disposal.)
Now, what’s available? Well, you can watch the screen run up and down, and try and get on the back of the momentum traders. Or you can stick your head down the lion’s throat, when a fund calls you and says, “I don’t like what’s on the screen at the moment. Make me a 1,000-lot copper market.”
That’ll be good, taking over the risk he doesn’t like, for 25 cents per tonne, with no better knowledge.
I’ve lost count of the number of times I’ve heard from brokers that the market is moving up and down, but “it’s all on line and we don’t know why, or who’s doing it”.
If we accept that interest income hasn’t really changed, and that warrant financing is still there, although with the bank/trader/warehouse monoliths lurking I can’t see that holding out too much hope for the independent for much longer, I think the picture looks quite bleak for the LME broker/dealer as a stand-alone entity.
I may be wrong.
Perhaps they had a great year in 2010.
After all, volumes across the exchange were up again, and volatility was certainly there, meaning prices moved a lot. In those circumstances, the way the market used to be structured, it should have been a golden year.
So what do I think the answer is? Well, first off, and I’ve addressed this issue before, account execs need to concentrate on selling systems; get your screen in front of the client
, and at least you have a chance.
Next, spread your wings. Forget being an LME broker; the expertise is no longer in knowing the non-ferrous metal market.
You have to able to offer the milli-second fastest trading platform, and your customer wants to trade a raft of markets across it. And make sure you can share your administrative and back-office costs across as wide a field as possible.
You have to be a generalist; the age of the specialist in our market is sadly coming to an end.