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Opportunities and challenges at the LME

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When Metal Market Magazine caught up online with LMECEO Matthew Chamberlain on Wednesday September 16, he had returned to his office just a few days beforehand for the first time since the UK government introduced a widespread lockdown on people’s movement in March to try to contain the spread of Covid-19.

The measures taken to limit the numbers infected by the novel coronavirus have impacted every London-based financial institution. For the LME, it has warranted acceleration of some plans while others have been delayed to reprioritise elements of the LME’s development in line with members’ and the markets’
needs and their available resources in extraordinary times.

“The Covid-19 situation has clearly impacted us in two ways. The first is as an employer and the second is as a market operator,” Chamberlain said.

“Like any other business, our primary consideration has always been about the wellbeing of our staff and their families. I think it is in times like this that you really rediscover that bond with your staff. You realise that companies do have a strong community, almost family, element to them.”

He has been deeply impressed by that from the early days, where “it was about planning and people working hard to put contingency plans in place,” through early March when it became obvious that this was going to become “quite impactful for the UK,” he recalled.

“Our colleagues in Asia had seen an earlier wave, so we had a little bit of a pre-warning there, but in early March it became obvious that things would have to change.” He noted the ability of LME staff to adapt and to help each other as increasing numbers of them began working outside the office. “Pretty much everybody went home except for essential personnel coming in, who have really done a fantastic job,” he
said. “But whether people were in the office, or were at home, I have been really impressed by that sense of mission, that sense of purpose and of mutual support amongst the staff, and also between the staff and the organization,” he stressed.

The second element has been around the stewardship of the market. “Clearly, the big element there was the closure of the Ring on the 23rd of March. It was one of the more intense periods of my professional life in the week preceding it, where it became clear that we were going to have to change and a great deal of work was done with staff here, with Category 1 members and the market more generally to get ready for that,” said Chamberlain.

“The 23rd of March was my last day in the office until last Monday [September 14]. It was extremely pleasing to see that liquidity go on to the screens, and to see the cash price settlement happen on screen, which never really happened before, was a huge testament to the ingenuity and adaptability
of our market.”

“So, it has obviously been a very difficult time in all of our lives. It has been a sad time for those of us who like meeting people, who like travelling and like the interaction of business, but I think that out of that sadness, there has been a huge number of positives,” he summarized.

Opportunities arising

Having adapted as quickly as possible to new global circumstances, many businesses have then looked at what opportunities they might offer. Have some emerged for the LME? “Yes, of course, there is absolutely an understanding that there will have to be some changes to all of our working lives and practices,” Chamberlain answered. “All businesses should and can look for those opportunities because: (a) it helps markets keep growing; and (b) because it offers a potentially interesting commercial angle.”

He provided the example of something that the exchange had already been looking at, but that he said the crisis has really accelerated – the dematerialisation of the LME’s warrant depository. “At the moment, all the LME metal on warrant is represented by paper warrants that sit in a depository here in London, and the process of withdrawing them is a physical process. You send someone on a motorcycle to go
and pick them up for processing,” he reminded.

“Although the Ring is one of the most obvious manifestations of concerns around remote working, actually there was an equally pressing concern about whether, if London went into a full lockdown and nobody could get into the City, warrants would still be able to move,” he recalled.

“We had been looking for some time at the dematerialisation of warrants. Effectively removing that paper
in the vault and representing them purely by an electronic record. That obviously already happens with things like shares, but they are much simpler because they exist under one country’s law. LME warrants
exist under many countries’ laws because they sit in London, but they reflect metal that could be in Malaysia or UAE or wherever it might be. So it’s a much more complex challenge,” he explained.

“So that is a good example of an area in which we had already done work, the crisis accelerated the demand, because people said that it is not a great idea to be exposed to this need for a manual, physical
process, and we managed to pick up the pace on that. We will have a fully electronic, dematerialised depository early next year. We have already had a discussion paper out on it and there was huge support from the market. So that is a good example of opportunity,” he said.

Volatile volumes

Trading volumes have always been a natural focus of attention for every LME CEO as one fundamental measure of the success of the exchange’s strategy, services and contracts. When reviewing progress at the exchange last year, Chamberlain highlighted the stability of the volumes of trade on the LME – particularly in copper, which reflected on-going hedging business – but what is his view on the impacts of the Covid-19 crisis on volumes in 2020?

“Throughout this, and whatever the volumes are, we are very confident that the price risk management function has continued to operate exactly in the way that we would expect,” he stressed first. “And that is doubly impressive given that we moved the pricing basis from the Ring to electronic. I have genuinely not had a single concern expressed from a client about the pricing that we are producing. And given the volatility of the market and, given the change in methodology, I think that is quite incredible and a testament to everybody in the ecosystem,” he added.

“In terms of volumes more generally, it has very much been a tale of two quarters. The first quarter was significantly elevated in terms of activity, as it always is in a volatile market, and in March in particular. Since then, volumes have been slower. Everybody had a very busy first quarter but, particularly over the summer, I think a lot of the physical traders have been sitting on the side-lines while working out where the market is going, so that of course has caused a bit of a slowdown in volume,” Chamberlain summarized.

He thinks that the overall net effect in 2020 should be in line with 2019, but he added that it is a slightly more complex story because of the difference between the first quarter and the rest of the year. “We’ll obviously see whether trade business picks up in September- October as we get into year-end,” he added.

Chamberlain also pointed to a more complex story amongst the different base metal markets. “You’re seeing almost an individual story per metal,” he said. “For example, aluminium volumes peaked quite early because there was all that metal being put into warehouse for financing.

Copper very much dropped off into the second quarter, but is now coming back as the price rallies, whereas zinc came back a bit later and then the others are probably still a little bit in the doldrums. So there has also been a metal-by-metal story. It’s a complex set of effects, as you would expect in a complex time in the business cycle. “All that said, we’ve got that great base of stable business and that will continue to power us through with no real concerns in that regard,” he concluded.

Moving along the pathway in a major initiative launched three years ago, in consultation with its members and market participants, the LME set out a long-term vision for the future of the exchange. In 2020, has the LME travelled as far along that Strategic Pathway as hoped?

“In the 2017 document, we identified some things that we were going to do, and to a very large extent we have achieved those; and some things where we said we would watch the market and see if they were desired,” Chamberlain recalled. One example of an item delivered, “I guess the most obvious, and probably the most fortuitous,” was the electronic pricing trial. “We were very lucky that we did that back in 2019, because clearly even though we decided not to maintain electronic pricing – we went back to Ring pricing for nickel – it very much smoothed the transition with Covid-19,” Chamberlain noted. “That is an example of somewhere where it acted perhaps in an unexpected way, but it was still good to do,” he added.

Another example of something enacted in a more expected way is implied pricing, where LMEselect now adds together the 3-month and the carry to produce outright third Wednesday prices. “We now have those prices on screen. We haven’t seen any fundamental wholesale change, but I think there was a concern from the market that if we went too far we would disrupt the date system etc. But we have some more activity on those,” said Chamberlain. “So that is an example of something we felt could be helpful under our user-choice model – not forcing people to do it – but where people wanted to trade that way, it has worked quite well,” he noted.

Chamberlain picked out new contracts as a third element. “Particularly with the steel contracts, we have always said that some will work and some won’t. Clearly the ones that are working are the steel ones, and we are excited to keep building those, and of course excited to get the Fastmarkets lithium contract launched, which is a great example of market engagement, with the formation of our lithium committee, and I think we are now reaching the right time for getting that out.”

He added, “In general, I feel the things that we said we were going to do back in 2017 we have done. Their actual market impact has been of varying significance, and, as with the electronic pricing, has in some cases gone in the way we didn’t expect, but is still positive. Overall, I’m happy that we took those forward.”

On items in the Strategic Pathway yet to be addressed, he said: “Clearly there are some things back in 2017 where we said, ‘Look, we will continue to monitor the market, and see if they make more sense.’ We haven’t put those into place yet – perhaps some of the more standard electronic elements that you see on other markets but you don’t necessarily see on ours. I don’t think we can make any decisions right now because I think we are still very much grappling with the Covid-19 situation.”

“Clearly, the fact that we have been doing electronic pricing for 6 months now gives us more data, and I’m sure that will inform a reconsideration of some of the other initiatives that we didn’t progress in SP17 to enhance the electronic market. I see it very much as a dynamic, living, breathing thing. I’m glad that we got done most of the things that we said we’d get done, and done before Covid-19. As and when the market normalizes, we can revisit and see what has changed and what has stayed the same.”

One of the long-debated topics likely to be revisited isthe future of the Ring (see box panel). Leveraging technology Under Chamberlain’s watch as LME CEO, investment in software and technology development to secure commercial advantage for the exchange has been a recurring theme. In discussion with Metal Market Magazine last year, for example, he pointed out the advantage of putting the technology in place to allow the launch of new cash-settled contracts swiftly and at relatively low cost to the LME. How will the LME be using that technology now?

“We have a bucket of contracts ready to launch. I would love to get them out by the end of this year, but we will have to see where members are in terms of change with that,” he answered. “That [the technology] works as we expected and that has given us the confidence to push ahead with, for example, the new trading platform, which is an even bigger step forward. That will launch in 2022 – it is making good progress and is due to go into testing next year.

Obviously, changing trading platform is a huge piece of work, but that will launch and we’re already thinking about what that enables us to do.” For example, the LME had a discussion paper out earlier this year on options contracts, looking at how the LME could build its options market and get more electronic liquidity for that – something that Chamberlain said will be enabled by the trading platform.

“Get the new trading platform and then enhance the options market – so it is that marriage of technology and commercial,” he explained. “It’s worth noting that, even before our proposals on the options market, and electronic options, our options volumes are looking pretty healthy and I think the RIBs (registered intermediate brokers) are partly to thank for that,” he noted.

“What I like is the fact that we are doing tech better – it is always challenging and nobody gets it perfect – but I think we are doing tech better. More importantly, we’re then thinking about the business outcomes. So getting new contracts launched when there is an opportunity – as there was, say, with China hot rolled coil – and seeing good growth,” he added.

The LME’s major new trading platform, due to launch year after next, is a joint project between the LME in London and its owner HKEX in Hong Kong, for which it is taking the HKEX OTP-C (Orion Trading Platform Cash) and turning that into the OTP-M (Orion Trading Platform Metals).

Chamberlain said that ambitious project is going well. “Our colleagues in Hong Kong have done an incredible job. We now have a development capability here as well, so it is a great example of cooperation between two parts of the HKEX organization.”

He noted that coding is at the front end of such projects and said that it is pretty much done. “We have a system and it works, but there is now a huge amount of testing, quality assurance, getting the members plugged in, connectivity etc., but where these – particularly converting a cash equity platform to a derivatives platform – have historically gone wrong in the past, we believe that we are beyond that point. So I am increasingly confident that we have a good product and that we are on the right track and I think that it is going to be very exciting,” he added.

Untapped Chinese potential

When HKEX bought the LME at the end of 2012, part of the combined strategy was to increase access to China’s rapidly expanding commodity markets.

Eight years on, Chamberlain admits that not all of the potential envisaged back then has been unlocked. “It is absolutely fair to say that we probably haven’t delivered on all of the elements of the China potential as we would have liked to, but that is the nature of a strategy – that some things have worked out and others haven’t.” he said.

“Looking at HKEX, clearly they have achieved great things in the equity space, with Stock Connect, and in the fixedincome space, with Bond Connect, so I think that it’s fair to say that, rightly, their focus has been on some of the other asset classes, and it has been easier to forge the co-operation with the mainland on those.

“In terms of commodities, we have done some interesting things that I believe are going to lay the foundation, but it’s a long game. So, for example, the QME (Qianhai Mercantile Exchange) is a business that produces very helpful and credible spot prices for onshore Chinese commodities. That is beginning to be an increasingly valuable asset for the group.” The HKEX London minis are intended to provide easier access for Chinese and Asian market players. “We have seen some volume on those, but it has not been huge,” Chamberlain acknowledged.

“So we’ve pushed forward all of the right initiatives, and we do need to do that because we believe in the Chinese potential. But, as I’ve often said in the past, there is an extent to which to be China’s trusted partner, you need to have the solutions ready to go, offered and be ready for when China wants to open these markets up, and we’re ready to be their partner when that happens,” he summarized. “Not forgetting that there are already very significant Chinese flows on our market in any event,” he added.

“China has always been part of our market, but what can we do to make that even bigger?” Latest initiatives explained Earlier this year, the LME issued a discussion paper on sustainability plans. The exchange intends to launch new contracts to support recycled, scrap and electric vehicle (EV) industries in transition to a sustainable economy. It plans to introduce LMEpassport – a digital register that enables a voluntary market-wide sustainable aluminium labelling programme – and plans to launch a spot trading platform for price discovery and trading of low carbon aluminium for interested buyers and sellers. The proposed LMEpassport and spot platform initiatives – which are subject to market feedback – are expected to launch in the first half of 2021.

“What I like about both of the initiatives – so LMEpassport, which is the transparency platform which allows data about metals to be made available to the market, and the spot trading platform – is that they have applicability both in our core ‘nuts and bolts’ business and in some of our growth areas, particularly ESG (environmental, social and governance reporting),” Chamberlain told Metal Market Magazine.

“Taking LMEpassport first, where it really started from was a problem we’ve been posed, from the warehouse community in particular, for the past ten years, which is how can we stop pushing around reams of paper, the certificates of analysis, and why can’t those be digitized.” Getting those mandatory documents digitized is the core use of passport. “I think all paper-based processes have come under a bit of scrutiny,” as a consequence of the Covid-19 pandemic, Chamberlain noted.

But it can then be extended, on a voluntary basis, to make data about sustainability, such as carbon footprint, available too, such as by producers who want to highlight their low-carbon aluminium products. “So it is a platform that has both a core use and a stretch case as it were,” he explained.

“The spot platform is exactly the same. We often get asked about launching new contracts,” said Chamberlain. He identified aluminium billet as an example in the context of growing stocks of aluminium in LME warehouses this year (see box panel). “We got lots of requests recently asking whether we could facilitate billet trading, and launching a physically settled billet contract is tough – any physically settled contract is tough – but a spot platform could allow new forms of our core metals to be traded in parallel quite easily.

“It also has a stretch case where if people want to buy and sell low-carbon aluminium or assurance-supply-chain cobalt, or whatever it might be – that’s the beauty of both systems, they are totally extensible and it is really just up to what users want to do –that is the exciting thing,” said Chamberlain. “I am really excited about both because I think we’re bringing good technological solutions to some really meaty metals market challenges,” he added.

Sustainability and responsibility

While there are links between sustainability and responsible sourcing, Chamberlain pointed out that the LME is dealing with them in different ways. “Responsible sourcing – i.e. supply chain assurance, avoiding conflict financing and child labour – is something where there is general agreement in the market that those things shouldn’t be in the supply chain and so there we have been able to take a much more rules-based approach. It is saying that, as of 2022 broadly, if you cannot demonstrate that you’re compliant with the OECD guidance, then we may need to ask you to leave as an LME brand. So that is a compliance-based approach, using the platform of our rules and our brand listings to impose global standards on a global supply chain,” he explained.

“I am proud that we’ve done that,” he added. “I’ll be honest, it was kind of scary at some points because when we started this in 2016-17, I don’t think the market had moved to a point where everybody was in agreement with this. We did, absolutely, even as late as last year, hear some people say, ‘This will hurt the LME, your competitors aren’t doing this, I’m just going to go and list my brand on other exchanges, and this will be the end of the LME. ’”

He said that was difficult to hear when you genuinely believe that you are doing the right thing, “but you don’t want to put your whole franchise on the line,” he recalled.

“I’m glad that we stuck with that because I think that, although the vast majority of the market has always been aligned with it, I think this past year has effectively seen everybody understand that this is something we absolutely have to do as an industry. And the work that industry bodies and that trade associations have done has been fantastic. I couldn’t be happier with how the industry has evolved and gone and I think we’re aligned with that.”

He said that environmental concerns about carbon emissions from aluminium production are not the same because it is not the case that everybody agrees that all aluminium should be low carbon and, he pointed out, supply of the metal would not meet global demand if only low carbon aluminium was allowed.

“So that is much less about hard and fast rules, because they could put people out of business and they could have a very significant negative social impact. It’s about a voluntary disclosure platform and then, if the market likes what’s being disclosed, then they can assign a premium to that if that is appropriate, and that sends the right economic signals.”

“So there are two sides of the ESG/CSR debate, but we’ve deliberately taken very different approaches and I’m glad that we’ve done that,” he summarized.

Plans in the pipeline

Several less high-profile, but nevertheless important, steps are pending. Use of a virtual trading ring for alumina in a condensed timeframe on a Wednesday morning to concentrate liquidity started to gain traction and was considered a possible model for other commodities. “We still very much like the idea on the illiquid contracts of focusing liquidity at a particular time on LMEselect. It began to work for alumina: we saw the first trade and we were looking at extending that to some of the other illiquid contracts,” Chamberlain noted. “But I think it’s fair to say that one of the negative effects of the Covid-19 crisis is that it has been hard to get mindshare on new contracts in 2020. Understandably, people have not wanted to change their business processes.”

He thinks it is unfortunate, since the alumina virtual ring was not doing huge volumes but it was at least trading. As of now, the idea is on pause because of the pandemic, “but the general principle is a good one for the less liquid contracts,” said Chamberlain.

A year ago, the LME and LME Clear had thought that it might be possible to introduce value at risk (VAR) for clearing by the end of this year, but it is now in the pipeline for after the launch of the LME’s new trading platform.

“Value at risk for clearing is very much on the agenda,” Chamberlain said this year. “Covid-19 impacts on books of work has meant that we don’t want to tax the members too much in terms of system changes, so we are very much prioritising the trading platform – that will be the first delivery. What we do on VAR will be later than the trading platform – so it will be later than 2022, which is the earliest go-live for the trading platform. It needs a lot of member engagement and we’ve modelled members’ portfolios for them under VAR and shown them the savings they will make. There has been great engagement and good buy-in, but it is a big technical lift for us and the members and we’re not rushing in the current environment,” he explained.

“We’ll get the new trading platform in and then VAR a few years down the line,” he added. Work on creating pre-trade transparency on the telephone market, required by MIFID II financial regulations, was temporarily delayed earlier this year as another consequence of the Covid-19 pandemic, but work on it has now restarted.

“There was the regulatory demand that we do something. Last year was very much about identifying the right solution and working with members to find a solution that met the requirements, but didn’t cause difficulties for the members in our market, and that is how we came up with the so-called FPA (fixed-price auction). We were going to implement that at the beginning of 2020, but we did defer that because it would not have been practical with member change freezes and no-one wanted to introduce operational risk at a time like this. But we have now decided to push ahead with that,”

Chamberlain updated. There is a balance to be struck. “You don’t want to cause operational risk, but at the same time most companies have got into their ‘new normal’ and they can make some IT change, and we don’t want this hanging over us. If we’re going to do it let’s get on with it, and then people can release project resources to move on to more profitable things.”

“So we are now pushing ahead with that and I think we’re going to go live with the testing and it will go live later this year. It is striking that balance between respecting the fact that people have got a lot to do at the moment, but at some point we just need to get on with it,” Chamberlain concluded.

To read the issue, please click here.

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