Imagine an open outcry market based around a circular red leather sofa in a medium-sized room where hand signals – hand lowered and index finger and thumb touching, among others – determine prices. Where the price of tin is decided between 11.50 and 11.55 Greenwich Mean Time and other metals in five-minute intervals throughout the day. An exchange that does not aim to make a profit but instead rebates any surpluses to members. How quaint, how outmoded, people may think. How wrong they would be.
The London Metal Exchange (LME) is one of the world’s top 10 international exchanges, with turnover up 50% in 2005 to $4500bn compared with a year earlier, while 78 million lots (ranging from five to 25 tonnes depending on the metal) were traded in 2005 compared with 72 million a year earlier. It is responsible for more than 90% of global trading in base metals. It is moving into new products: last year it successfully developed and launched futures contracts for various plastics and this year it has started the same process for steel prices.
Fear of change
Many practitioners, not surprisingly, sing its praises and are wary of change, although others, like Barclays Capital, believe the exchange is right to change. The LME’s decision to split ownership and trading rights this spring, and have its top executives assess the implications of running the market for profit, has spooked those who do not want change. They fear that if it listed, it might be bought by another exchange as part of the general wave of consolidation in markets, that the interests of marginal members of the exchange – whose priority is a quick profit rather than the longer term future of the LME – may predominate, that liquidity may suffer if there is a move to have all trading take place electronically and that fees could be raised disproportionately.
“The LME is an unique market and a strong market,” says the global head of metals at one of the biggest players on the exchange, who asked not to be identified. “If it ain’t broke, it doesn’t need fixing.”
| Exchange chairman Donald Brydon gives a conditional agreement: “The LME is one of Britain’s great success stories,” he says.However, the softly-spoken Scotsman, who retired in June as chairman of Axa Investment Managers but continues to chair some of the fund manager’s other companies and occupies the same role at entities as diverse as engineering company Smiths Group and children’s charity EveryChild, adds: “We are not for sale. That is not an issue. The issue is that there are juggernaut threats coming at the exchange and just pretending we can carry on exactly as we always have done and everything will be fine is a pretty optimistic strategy.” |
Mr Brydon, a former rugby player, also points out that market participants may “profess great love of the institution but, at the end of the day, if it doesn’t suit them to participate in the market, they will go off and do it somewhere else.”
It is true that the romance of the LME, a market created in 1877 to help the dominant British merchants hedge against their sailing ships going down, is beguiling – although on a hot, wet London day, as sullen schoolchildren in steamy woollens watched the LME proceedings, it was doubtful they felt it.
Controversy over price rises
The LME continues to fulfil its original aim but the five-year commodity boom has accelerated the entry of speculative hedge funds. This is a cause of controversy because other traders and analysts blame the hedge funds for a rise in prices not tied to fundamentals – one commodity analyst says the exchange is now “a playground for hedge funds”.
A study published in May by the Man Group, a brokerage and asset management company that is heavily involved in commodities, concludes that fundamentals continue to matter over the long run but in the short run, “[hedge] funds will dominate short-term trading and direction”.
Mr Brydon believes that, at its core, the LME serves the interests of the producers and users of metals and plastics but that “we are agnostic as to why somebody wants to hedge”. First, he argues that the distinction is not that clear: “Just because something is called a mining company does not mean they only ever hedge their forward production. They may also take a purely financial position.” Second, he goes back to the basic economic theory that the more players there are in a market, the more likely it is that there will be better price formation, in part on the back of that liquidity.
“That does not mean you don’t have speculative bubbles but they happened long before hedge funds came along,” says the 61-year-old married father of two.
Sitting in the humble offices of UK-based charity EveryChild – indicative of his lack of pomposity despite a host of initials after his surname (OBE and CBE) and membership of the Establishment – Mr Brydon describes its aim as protecting children in some of the poorest countries of the world and says his involvement began when he saw a documentary on children in a Romanian orphanage. “I saw these little kids with shaven heads just rocking back and forward in their cots and I cried,” he says.
Four challenges
Protecting the LME’s supremacy against what he calls the juggernauts is also Mr Brydon’s role. He enumerates four challenges, namely technology, the transformation of exchanges, China and regulation, all of which the LME executives are continuously considering.
Trading can currently take place in the ring, in the inter-office telephone market or on the exchange’s electronic trading platform. The LME is not biased towards any of these – the electronic trading platform is growing but is still small compared with the ring, says the exchange, which does not publish a breakdown of trades done on each platform. But it wants to ensure it has the most efficient, least expensive way of trading from the point of view of the end customer, to ensure it maintains its lead.
This technological challenge ties in to the changed landscape for exchanges. Commodity exchanges now command much higher earnings multiples when they list, giving them significant resources with which to compete and making that competition more aggressive. That is one of the reasons why becoming a for-profit entity in whatever format may be necessary for the LME’s longer term future.
China, the main engine behind the rise in commodity prices as it feeds its boom, is “perhaps the biggest part of the puzzle”, says Mr Brydon. “What does China do? Ultimately, is there going to be a major long-term issue about how the Chinese market develops? And whether we are smart enough and flexible enough to cope with it.”
Open longer
On June 1, the LME’s electronic platform extended its hours. It now opens six hours earlier to reinforce and broaden its importance for the Asian market and compete with the Shanghai Futures Exchange.
Meanwhile, the mixture of the regulator’s call for greater transparency and the Markets in Financial Instruments Directive means that the LME is under the same incremental pressure that besets all those involved in the financial services industry.
Mr Brydon’s other roles include being a thinker on financial services – his honours are due to services to the industry – as well as a lone Scottish voice against devolution. Interviewed during the World Cup, when a number of high-profile Scots, ranging from tennis stars to politicians, caused an uproar in the national press by saying they would support any team but England in the football matches against other countries, he rails against the “unattractive phase Scotland is going through. I personally think devolution is a disaster. What it has done is to create fissures in the UK, which was a successful and cohesive entity, for an advantage that has never been spelt out and without any serious study of what the consequences will be.”
As for the consequences and advantages of EveryChild, they are too numerous to list here. One of Mr Brydon’s aims, though, is to find an annual sponsor of the charity’s magazine, a snitch at £6000 (€8700) and such a small number that it barely registers as a percentage of the LME’s annual turnover.
