London 05/01/2016 - Warehouse operators may take legal action against the London Metal Exchange (LME) should it press ahead with a charge capping (CC) proposal, sources told FastMarkets.
The likelihood of a lawsuit would depend on the rent and free-on-truck (FOT) levels that warehousers would be permitted to charge under CC. Should operators see the cap as "reasonable", the appeal of legal action would lessen.
"If the LME finds common ground and caps rents and FOTs at a level that suits all, then I think warehouses will play along and even agree to freeze rents and FOTs for a few years," a warehouse source said.
"But if the LME went for rent caps at a silly low number, then warehouses may actually throw their toys out of the pram and exit LME business altogether," he added.
While the LME does not yet have the ability to set rates for warehouses, it was concerend after warehouse operators proposed sizeable increases in FOTs and rents for the year from April 1. It is currently reviewing rates that "do not appear to be based on objective economic factors", it said
The stock-weighted average increases for both rents and FOTs are significantly higher than in the previous two cycles at 10 percent for rents - compared to a three-percent annual rise in the last two years - and 12 percent for FOTs, compared to two percent for 2014 and 2015.
Metro was the hardest hitter, lifting fees by more than 30 percent at some locations.
“Metro really put its neck on the block – everyone else was fairly restrained,” a second warehouse source said.
Warehouses attributed the extent of the rises to tough economic conditions and the higher costs of complying with increasingly stringent regulations.
Sources were divided over whether the exchange would be able to get CC past the European Commission's (EC) anti-competition regulations although the rulebook is ambiguous and therefore open to interpretation, some said.
"Competition law is not black and white - it is complicated but in general the EC do not like a price cap as everyone floats to the top and this removes the competition," a source close to the matter said.
The LME is different, he added - rates set by the warehouse are negotiable and operators offer incentives to attract material.
"Everybody knows that no one pays the high fees," he said.
CC could protect metal owners, reduce the harmful effects of high incentives and ensure competition between warehouse companies, the exchange suggested in a 2015 discussion paper.
Still, the LME will only press ahead with CC if it is confident of being able to defend its positon if challenged, FastMarkets understands.
"It is almost certain that [warehouses] would litigate… we kept the powder dry before but this is a much more clear case," a third warehouse source said.
Warehousers, as independent businesses, have every right to set prices "as we see fit", the second added.
"The current environment is a race to the top but it is anti-competitive to set the levels - if you owned a shop, you would not want your customers coming in and dictating the price," he added.
Indeed, several are unhappy at being dictated to by a third party but the LME has little choice but to go down this route to "create a level playing field", others said.
"If they do not control the rent and FOTs, it will spiral out of control… other warehouses would certainly increase rents again next year to match Metro," the first source said.
"Rent capping would make life easier, especially for the old-fashioned warehouses. Of course, it is a challenge to come up with the right number. But if you have sizable tonnage, every cent counts," the fourth said.
Should the LME decide it has a strong enough case to press ahead with CC, it would most probably consult the market and/or issue a discussion paper before giving warehouses three months to prepare for implementation. Theoretically, it could put CC in place by the end of this year.
The LME therefore advised warehouse operators to consider the consequences of paying incentives during 2016-2017 on the basis of the full level of 2016-2017 rents and FOT.
(Additional reporting by Perrine Faye, editing by Mark Shaw)