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LME faces new challenge, this one from its own members.

The London Metal Exchange brokers are facing something of a double squeeze on their core business

By Andy Home/London

If you want to understand why some members of the London Metal Exchange (LME) are so unhappy with the way things are going that they are considering forming their own metals-trading platform, look no further than the latest exchange notice to members.

Dated Monday, the LME said it has received an application for exchange membership from Jump Trading Futures.

If accepted as a Category 3 ("Associate Trade Clearing") member, Jump Trading will be able to trade and clear its own business on the LME but won't be able to issue client contracts or trade on the open-outcry ring.

Chicago-based Jump Trading describes itself as having been "at the forefront of algorithmic trading since its founding 15 years ago".

It is symptomatic of the new breed of player trading on the world's oldest metals exchange.

It is also precisely the type of company being targeted by the LME as it seeks to boost liquidity in the face of reduced volumes from its industrial user base.

That in itself might be enough to disconcert traditionalists, who fear that the LME's drive to capture more financial players risks marginalising the producers, merchants and consumers who have historically been the back-bone of the exchange's pricing dominance.

But Jump Trading's potential membership poses another, more clear and present danger to LME brokers.

It is not only an existing customer of the market but a very big one indeed.

Quite evidently, if it gets the rights to trade on its own behalf as an LME member, it's going to mean a loss of commission fees for all those who have previously brokered its business.

LME brokers are facing something of a double squeeze on their core business.

Both derive from the changes introduced to the market since it was bought in 2012 by Hong Kong Exchanges and Clearing (HKEx).

HKEx has sought to claw back some of its $2.2bn outlay on the LME by raising trading fees.

The impact of the fee hikes has been particularly evident in some of the short-dated spreads, such as "tom-next", which literally means trading tomorrow to the next day. "Tom-next" has historically been a highly liquid spread, not least because it was in essence free to trade under the LME's old mutual limited-profit model.

That's no longer the case.

Brokers face the unwelcome choice either of absorbing the cost of trading it or passing that cost through to the customer.

The net effect is that "tom-next" volumes in the aluminium contract, for example, have slumped since the fee changes were brought in early 2015.

The LME, meanwhile, has introduced a number of changes intended to boost electronic trading, particularly for the benchmark rolling three-month delivery price and the spreads between that price and other major prompt dates in its spreads spectrum.

The biggest carrot being offered proprietary financial trade houses such as Jump Trading is the ability to access directly the LME's electronic trading system Select rather than go through a broker.

A carrot Jump has just taken.

From the LME's perspective, it is a way of opening up the arcane London market to the types of operator already populating other major financial markets.

From the perspective of LME brokers, however, it represents another nail in the coffin of the old market with all of its weird and wonderful features such as open outcry trading and plethora of spread trades.

Which is why a number of them, just how many we don't know, have asked Martin Abbott, former LME chief executive, to oversee a feasibility study on the viability of a new trading forum.

There has for some time been plenty of low-level chatter on the LME Street about just such a move but the inference from Monday's formal announcement by Abbott is that there are sufficient numbers interested to justify the cost of a study.

But is it anything more than displacement activity for those that feel disenfranchised by the recent direction of travel of the new LME?

There are grounds for thinking that there might be.

Firstly, there is a precedent for LME brokers adopting an entirely new trading forum if they feel it is in their interests to do so. Spectron launched an electronic metals trading system in 2000 to capitalise on the LME's lagging efforts to get its own offering up and running.

Andy Home is a columnist for Reuters. The views expressed are those of the author.

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Publication:Gulf Times (Doha, Qatar)
Date:Jun 7, 2016
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