The involvement of the CFTC is doubtless of real concern in some quarters since a foreign regulatory body will be reviewing with fresh eyes the traditions and practices of the LME which have endured for 135 years; the LME is, after all, one of the last bastions of the City of London.
The problem is that LME-registered warehouses do not have to deliver more than the stipulated LME load-out rate, currently a maximum of 3,000 tpd. Additionally, LME warehouses are free to set their own warehouse charges, which have significantly increased in recent years.
The problem has been longstanding, but the past 18 months have seen ever-increasing backlogs for physical metal, which – combined with increased rents – are having an impact on costs, notably for customers in the aluminium market.
The most recent complaints have a sharper slant. It is not just the delays, but the reasons behind those delays that are in question: notably an allegation that those who had representation on the LME warehousing committee have a conflict of interest by virtue of their ownership or interest in the LME warehouses themselves.
There is also a suggestion of market manipulation by those controlling the warehouses, which in turn, it is alleged, has affected the cost of the underlying commodity, beyond an increased carry cost.
Where the solution lies is not straightforward.
First, in the USA, legal context allegations generally carry no adverse cost consequences, and therefore cannot be taken at face value. The LME would not want any changes to be seen as a response to unproven allegations.
Second, the current LME rules for warehousing metals are not extensive, but they have hitherto proven effective for the market that they serve.
However, not only are the LME warehousing rules not extensive, but sanctions for violations are not specified.
For example, in the event a warehouse does not appear to meet the LME criteria, there is “an initial consultation with the warehouse company concerned”.
The warehouses need time to make changes
According to LME policy, if there is any change in the warehousing rules, warehouses are allowed to upgrade or relocate over “say six to twelve months”.
The ultimate sanction on a warehouse for breaking the rules is, of course, the withdrawal of the LME licence, but the LME rules do not specify when and how this can be implemented.
In these circumstances, and absent any specific terms agreed with the warehouse, the LME is bound to be mindful that any major changes will require reasonable notice, perhaps more than twelve months, to allow warehouse infrastructure changes to be implemented.
Any failure to give reasonable notice could expose the LME to legal actions from the warehouses themselves which, in turn, would add to the current difficulties.
The LME is embarking on a consultation process, which is clearly the right course to follow, and which focuses on reducing delays for metal to 100 days. The exchange rightly recognises that the improvements in logistical support that will allow greater throughput will come at a cost, which may be considerable.
But changes have to be made.
The US lawsuits, CFTC inquiry and now the involvement of the Financial Compliance Authority have caused a head-wind that is unlikely to abate.
It is not just the threat of regulatory involvement or lawsuits that the LME will have in mind – the exchange needs to placate major consumers and maintain confidence.
Failure to do so might spur the creation of competing metal warehousing arrangements outside the LME, which could erode its prominence.
John Whittaker is a partner in Clyde & Co Commodities, London.
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