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London Metal Exchange to Bolster Benchmarks With Tougher Rules

Wednesday, 27 March 2013 01:28 PM

The London Metal Exchange, spurred by new regulatory pressure across financial markets, plans to tighten rules for its trading floor where global benchmark prices for materials like copper are reached, industry sources said.

They said the changes aim to increase liquidity and thus curb sharp price moves at the end of the shouted "open-outcry" trading sessions, so prices reached then gain extra credibility.

The initiative is partly a response to the spotlight shone by regulators on all benchmark pricing mechanisms after the Libor rigging scandal last year that exposed interest rate manipulation by banks in London.

"With the Libor issues out there, everyone is becoming very sensitive as to how prices are set or fixed, so every little thing you can do to improve that is a good thing," said one source familiar with the matter.

About a dozen trading companies and banks pay the LME for the right to send traders onto the circular floor known as the "Ring" in the LME building on Leadenhall Street in London's City financial district, where they shout bids and offers and clinch deals on behalf of themselves or for clients.

While many other financial markets have scrapped such voice trading to conduct business electronically and by telephone, many metals traders say retaining open outcry as well offers the best way to discover prices that truly reflect the market.

Faith in this mechanism means businesses worldwide use some prices reached in Ring trading as the basis for their trades in physical copper, aluminium, lead, tin, zinc and nickel.

But sources say some LME members and the exchange itself worry that floor traders often do not take on orders that are big or risky enough to truly represent the market at the end of the last part of the day's open outcry business, the "kerb."

The fear is that these crucial prices, used by market participants to calculate daily profit and loss, can be based on trading of a few or even one lot: 25 tons in copper's case.

"By not taking on enough risk it starts becoming a one-lot market. There needs to be more risk-taking to ensure proper liquidity and a representative price," said a source at an LME Category 2 broking company, which places orders by telephone through a Category 1, or Ring-dealing, member.

One rule due to take effect this year is that any deal at the final kerb trading close must be for a minimum of 10 lots, with some exceptions, three sources familiar with the matter said.

The LME, which was bought last year for $2.2 billion by Hong Kong Exchanges and Clearing (HKEx), declined to confirm or comment on the new rule.

The change seeks to prevent the closing price of a metal being based on small tonages, which could skew the level.

"With smaller lots, the bids and offers that are made are not really there to be traded for any volume and that reduces the credibility of that price," said another executive at a Category 2 member firm.

"Doing it this way (a larger size) enhances the ability for the price to be credible. It makes the Ring more relevant."

A larger minimum trading size would also help reduce the potential to deliberately push prices one way or another in the moments before the 5 p.m. kerb close.

"I think the feeling is that 99 days out of 100 there's no problem," the first source said. "If the close does have a problem on one day in 100, (they) are trying to iron out that one day."


Unlike the Libor rate, which is based on bankers' opinions, the LME's metals levels are traded prices. There is no suggestion of any regulatory investigation of any LME price mechanisms.

But all exchanges are alert to increased scrutiny of benchmarks which is beginning to focus on precious metals price discovery, which uses a different method to LME mechanisms.

The U.S. Commodity Futures Trading Commission has had "a couple" of conversations about whether the daily setting of prices for gold and silver in London is open to manipulation.

The International Organisation of Securities Commissions (IOSCO), a global group for markets regulators, is conducting a wider review of price benchmarks and is set in May to publish a report with principles on how to compile them to avoid rigging.

Meanwhile, a second rule due to come into effect in the LME is designed to ensure business done in the Ring is concluded as quickly and efficiently as possible after the close.

From June, the LME will bring forward by 15 minutes and will narrow to 15 minutes from 20 the time "window" in which LME members can object to a price after the close of Ring trading.

"This latest modification is part of a series of enhancements designed to add further efficiency and transparency to the procedures used to establish the closing prices," the LME said in an e-mailed comment.

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The London Metal Exchange, spurred by new regulatory pressure across financial markets, plans to tighten rules for its trading floor where global benchmark prices for materials like copper are reached, industry sources said.
Wednesday, 27 March 2013 01:28 PM
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