"Don't throw out the baby with the bathwater" is a well-known
It warns those contemplating a major overhaul of a company or
organisation to be sure of its core values before they start on
slash and burn reorganisation. Otherwise they might close down
what's really valuable at the same time as shedding low-value
Looking at the contenders in the race to acquire the London Metal
, it looks as though the baby and bathwater idea is
one they would all do well to keep in mind as they contemplate
how they would tweak its operations to yield more profit. True,
there are potential benefits of synergy and much-enhanced
footprint for all of the external bidders. But we must
recognise that making money is their main aim.
And, no, I have not forgotten that one of the contenders could
well be the existing owner-members if they decide not to sell.
For one could assume the bids would have given them a
sufficient fright that they would immediately return to some of
the issues about LME operations currently seen as needing
reform. High on anybody's list of such issues would be the
LME's relationship with its listed warehouses and the vexed
question of load-out rates.
I first alluded to this baby and bathwater concept (without
actually then quoting the adage) some twenty years ago, when
the LME was contemplating an operational change that might have
impacted on the settlement price, and so would have interrupted
the flow of those numbers that all the industry's price-takers
had an established pattern of using.
I pointed out that many of these companies in downstream
sectors of the industry had no other dealings with the LME
except as takers of its prices. Operating in volumes or forms
of the metal too far removed from an Exchange warrant to be
able to hedge, they gave no business to brokers and made no
contribution to the market's liquidity. But by their use of the
LME's quotations as the basis for many millions of dollars'
worth of business, they conferred a cachet on those numbers
that was unquantifiable - unless they stopped doing it. Only
then would the true worth of this endorsement of the LME and
its price-discovery function be established.
Much has changed in the world of futures since then, most
notably the speed, duration and predictability of the average
cleared transaction. When the LME's founding fathers 135 years
ago established an organism to facilitate the hedging of risks
that were being precisely measured to the nearest day, they
could be excused for not foreseeing today's algorithm-driven
trades - measured in nanoseconds and their occasional
contingent need for massive, sudden movement of warehouse
So, as far as the LME has come, especially in the current
century, it clearly has further to travel, starting now.
It is at this point that the substantially different cultural
backgrounds of the bidding exchanges, as well as the
much-evolved balance of interests of LME's members and clients,
become highly relevant. When the Exchange itself has several
times visited the question of whether to retain the Ring and
has greatly developed its electronic trading platform, it would
surprise no-one if each of the external bidders already had a
programme to push that question to a prompt resolution.
Even the LME's daily prompts are freely spoken of as
potentially up for close examination by a new owner. Since
these do not figure in the experience of any of the external
bidders, that is hardly surprising.
So, here's the core question: what is really "baby" and what
Peeling the onion
Working inwards from the outer layers of the onion,
those price-takers for whom I spoke up 20 years ago must be one
of the first for scrutiny. True, the exchange makes money from
the dissemination of its prices, but this is small beer
compared with brokerage revenues. Then we come to the
warehouses, already a difficult contentious issue doing nothing
for the LME's popularity. Nobody else has the same problem,
because nobody else has set up their warehouse service in such
a trade hedger-friendly way.
This brings us to the strategic question of where growth in LME
business is to come from. With world production and consumption
of metals finite numbers, there are ultimate limits to the
volume of trade hedging business that can be given to the
Exchange. No such constraints apply to trades by hedge funds,
banks, sovereign wealth funds and the like. And with the thrust
of legislation towards much more clearing of what is now OTC,
and thus off-Exchange, business, the balance can only swing
further towards financially- rather than industrially -
So no more than two layers of the onion down, we are looking
critically at trade hedging. It is already clear it is no
longer dominant in the outlook for volume. How important is it
going to be to retain all the anomalous (on a global
perspective) facilities that are necessary for trade hedging to
continue as hitherto? Is it actually bathwater?
The importance of trade hedging
Just as I declared an interest twenty years ago on behalf of
the price-takers (and they are still all with us), so I must
now declare an interest on behalf of trade hedgers.
The one thing they have demonstrated through 135 years is their
Indeed, when you recall the third quarter of the last century
and the strenuous efforts made then by some major base metal
producers to steer clear of the LME, trade hedgers actually
have a growth history.
Such a conclusion cannot yet be reached about
financially-motivated trading, partly because its history is so
short. Even the prospect of more OTC business being forced to
be cleared, as mentioned above, is not a guarantee of a
commensurate growth in Exchange business. And the LME is still
a couple of years off having its own clearing house.
More importantly, nobody can guarantee that
financially-motivated metals trading will not, at some time in
the future, shrink as rapidly as it has ballooned.
I might concede that trade hedging is no longer the whole of
the baby (or soon won't be). But I am certain that it is still,
and will remain, an important part of it, and definitely not
If I was an LME member evaluating the merits of the external
bidders, and I wasn't too near to retirement, I would be
looking very closely at their respective performance in, and
recognition of, trade hedging. And I hope that I would then
cast my vote on that basis, and not the price bid.
Trevor Tarring is the former chairman of Metal Bulletin