London 01/03/2016 - Warehouse operators registered with the LME are braced for an extended struggle with the exchange over its proposal to implement charge-capping (CC) on rents and FOTs.
The exchange expressed disappointment that warehouse operators did not make larger cuts to their proposed 2016-2017 fee increases after it provided a two-week window for changes - only Metro and Istim, which had previously proposed the highest rate rises, revised them lower.
The LME now plans to publish a discussion paper in mid-March outlining its options regarding powers to cap rents and FOTs.
A cap could protect metal owners, reduce the harmful effects of high incentives and ensure competition between warehouse companies, the exchange said.
But the outcome of the CC proposal is likely to be many months away, warehouse operators warned, and could face legal challenges en route.
"The LME will take great care to prove to the regulator that it has gone through all the steps but it is likely that it will be legally challenged. We are going to see another period of endless consultations, and see a Rusal situation, which puts everything on hold and pushed further down the line," a warehouse source said.
In 2014, the Russian aluminium producer challenged the LME's implementation of load-in/load-out rates (LILO), calling the rule change "unfair" and "unlawful" because the exchange failed to examine other options.
Rusal won a first court case in March - the LME consultation should have included a robust discussion on the possibility of banning or capping of warehouse rents, the court ruled.
This was overturned in October when the LME won an appeal. Rusal was denied leave to appeal in December 2014, allowing the exchange to implement the rule change last year - many months after originally proposing it in November 2013.
"Legal action is costly and time-consuming," a second warehouser said. "Should warehouse operators decide to press ahead with a challenge, it would be some time before CC gets introduced - if in fact it ever does."
Other warehouse operators accused the LME of creating a system in which rates can only go lower and of failing to recognise the higher costs of doing business amid a more stringent regulatory regime.
"The LME have always put pressure to level rates, regardless of anti-competition rules. We believe rates are at a level which is needed to survive. Yes, the rates have gone up more than ever but we are being hit by more rules than ever and there has to be a reflection of this," a fourth source said.
But the status quo must change, Matt Chamberlain, LME head of business development, told FastMarkets.
"Warehouses absolutely have the right to a viable business model but, where high charges are used to fund high incentives, this is undesirable for the effective functioning of the market, and many market participants - including warehouses - have asked us to take action," he said.
It is unusual for a metal owner to pay the headline rate and incentives are traditionally offered by rival warehouses to attract metal into sheds - historically, the higher the rate, the better the incentive. These incentives will now be visible to the LME from next month and could help highlight what the 'real world' price for storing material is.
There are several ways in which CC levels could be set, FastMarkets understands. The first is setting a fixed increase of, for example, three percent each year. The second is to cap increases at the level of inflation and allow the 'real world' prices to catch up. LME sheds could also see a gradual decrease in fees until they match 'real world' levels or they could be immediately brought into line with 'real world' prices.
"There is now massive uncertainty for warehouse owners and massive changes ahead," the third source said. "Running an LME shed is a difficult operational challenge - the increases we have posted hardly touch the side."
As well, the opening of the one-week window to allow changes to be made to proposed fees made a lowering of rent and FOT increases near-inevitable, warehousers said.
The rates, which are submitted blind - warehousers did not know what their rivals' rates would be - were published at the end of last year. These numbers provided a target or framework for the "outliers" to bring their proposed rates into line with the rest of the market, the first warehouse source said.
"There was no way anyone else was going to reduce [their charges]," he said. "If you have inadvertently created a target, why would you reduce it and put yourself at a disadvantage?"
The resubmission was helpful in addressing the issue of certain operators charging high rents and FoTs in the warehouse sector but market participants are still unhappy that the aggregate levels are so high, the LME's Chamberlain said.
"We are happy that some warehouses chose to reduce their rates as that reduces the anomaly of extremely high maximum charges in particular locations - but across the sector, charges are still too high," he said.
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.
Still, because other parties as well as warehousers can respond to the discussion paper, a range of responses is likely. If most are positive, it could give the exchange the impetus to proceed.
But the EC generally disapproves of price caps because "everyone floats to the top", thereby reducing competitiveness, a source close to the matter said.
"The EC likes to see a spread of price levels and if you look at the current warehouse landscape you will see a spread. But it is not reflective to the LME market and the EC may not understand that," he said.
The EC may look unfavourably on CC if, in a likely scenario, all warehousers raised their fees to the top level. The exchange would have to ensure that it could document and prove why this CC measure needs to be taken.
The LME hopes to have CC in place by the next year's rent cycle although this depends on whether it faces any challenges.
(Editing by Mark Shaw)