London 22/03/2016 - The LME's proposal to increase accountability for large market positions could appease some market participants who have become frustrated by the repeated squeezes in the aluminium market.
The exchange will consult members about creating a more transparent reporting regime for positions that are above certain levels, it said on Friday. Exceeding the relevant accountability levels will allow the LME to request further information about the position of that account or linked account.
The LME has always had the ability to drill down to see who holds what material, FastMarkets understands, but discussions between the exchange and the metal holders had been on a more informal basis.
Now, the onus would be on the member to report a large position; should it fail to do so, the member would then be in breach of regulations.
In November, FastMarkets reported that JP Morgan Chase & Co was behind the aluminium squeeze at that time.
Other big squeezes have followed, the most recent of which preceded the March date becoming prompt. Because aluminium is used heavily in financing, a contango structure makes it a safe-bet easy trade. But with dominant holders increasingly a feature, JP Morgan once again found itself in the spotlight.
"It is something that clearly people in the aluminium market are annoyed about as they are not getting the price they expected and attribute this to the dominant holder," a source close to the matter said.
It is by no means certain that JP Morgan has been responsible for any squeeze. The names of other trading houses and banks have been bandied about, which reflects the fact that position holders can - and do - change hands and the identity is not made public by the exchange.
JP Morgan declined to comment.
While some participants have questioned the bank's silence in the matter, a bank is unlikely and under no obligation to comment on its trading position.
"They may just have to take a bullet on this," the source close to the matter said.
The continued presence of a dominant holder has started to attract the attention of the mainstream media, leading market participants to question the timing of the consultation announcement.
"It has been picked up that the consultation was pretty swiftly after the JP Morgan story hit the streets. I imagine the LME would have wanted to highlight that everything is above board," a trader said.
But others have said that the consultation had been in the making for several months as part of a series of reforms that the exchange is pursuing.
Indeed, despite the grumbles from those who have felt the pinch of the squeeze, the perpetrator has not actually breached any LME regulations.
Under the LME's lending guidance, a market participant can build a large position but must be prepared to lend at flat rates when the position becomes prompt if the latter exceeds 50 percent of warrants, TOM and cash.
"They are not breaking any rules and are well within LME regulations, but there are people who are getting irritated by it and they have started to make a fuss," an industry analyst said. "Ultimately, when one company finds a way to effectively print money, it will attract heat and tension from others."
A metal owner can also become a dominant holder accidently if metal continues to be drawn down from warehouses, which has been the case in aluminium. Stocks have fallen to 2.8 million from a more than 5.4 million tonnes in 2014.
"It is easier to have a large position nowadays - it makes it seem like a bigger deal than it is," the source said.
Being a large holder of metal is no indication of any wrongdoing, particularly if its position is of client trades and is not for the holder's own book.
"Given that banks have pulled back from commodities, clients have fewer banks that they are able to deal with… it is logical then that they will end up with one big bank," the source said.
The landscape has changed since the LME announced the consultation, particularly as further warehouse changes in the form of queue-based rent caps are set to come into force on May 1.
The dominant holder disappeared at the end of last week having been in the 50-79 percent bracket at the start. Today's warrant holding data shows there is just one holder in the 30-39 percent bracket.
The forward spreads have collapsed - the benchmark cash/threes was swung to a contango of $24 from a backwardation of more than $25 earlier this month.
And more than 350,000 tonnes has been cancelled for removal since March 17, mostly in Vlissingen but also in both Baltimore and Detroit.
"Could this be the consequence of the LME's new consultation on accountability levels or maybe a retrenchment by the big US bank so prominent in the news about the recent backwardation in the market?" Triland questioned.
Should the LME push ahead with the new accountability rules - it is seen doing so almost universally - the squeezes in spreads, which have become a regular feature of the market, could end.
"The new accountability report could mark the demise of the dominant holdings - the dominant long may want to ease back due to accountability levels, as this is the first time that there has been a formal definition" a market participant said.
There would be no way to generate tightness other than to remove the aluminium from LME sheds should the consultation end in the new rules being adopted, Triland added.
And while another analyst warned the LME to be careful of "unintended consequences", he welcomed the potential end of the dominant-position squeeze the proposed changes would bring about.
"There'll be those that say the LME's strength has always been low levels of intervention and adoption of free-market practice but realistically most markets have some form of controls and requirement over large position reporting, so why not?" a Category One member said.
"As long as the regulations are transparent, then everyone knows where they stand - theoretically, at least," he added.
For now, the market is in wait-and-see mode. The deadline for consultation responses in April 8, and these will have to be analysed before making a final decision.
"It will be fascinating to see how this plays out. It is a lot harder to explain contangos and backwardations to the non-initiated but bank regulation is something that divides opinion," the first analyst said. "I am not sure what will happen but I am sure those playing the games are not impressed by the scrutiny."
Three-month aluminium fell through $1,500 to at its cheapest since February 12 at $1,495 per tonne.
(Editing by Mark Shaw)