London 14/04/2016 - Aluminium stock levels in the LME warehouse system could slump should the exchange push ahead with the regulatory changes outlined in a recent discussion paper, market participants said.
There has already been a mass exodus of metal from listed warehouses ahead of the imposition of a queue-based rent cap (QBRC) on May 1. LME aluminium stocks at 2,721,500 tonnes are around their lowest since January 2009; more than 46 percent of that metal is tied up in queues and is therefore unavailable.
In a bid to crack down on warehousers' free on truck (FOT) charges that it considers to be too high, the LME has also proposed further measures - including fixed-term warehouse agreements (FTAs), charge-capping (CC), charge threshold guidance (CTG), charge-based incentive guidance (CBIG) and FOT conversion (FOTC) - that could see even more metal come off-warrant.
But there are fears that the new measures - both those pending and in discussion - could weaken the structure of the LME by encouraging more material to move off-exchange to storage where these is a lighter regulatory touch and lower costs of compliance.
Vlissingen has been the epicentre of the recent surge in cancellations. This week alone more than 244,000 tonnes has been booked for removal, taking total cancellations to 898,975 tonnes and stretching the queue there to more than 250 days.
"Roughly 800,000 tonnes of metal would be unrentable from May 1 if nothing changes between then and now," an analyst said.
EXODUS 'NOT DETRIMENTAL'
But the shift of metal off-exchange would not be detrimental to the LME's physically backed aluminium contract, the LME countered.
"Looking at LME stock levels over the past 30 years, at one point during the economic boom there was just over one million tonnes held on exchange and the LME still worked," Matt Chamberlain, the LME's head of business development, told FastMarkets.
"The amount needed for settlement is low and, if metal is starting to leave the system, that is not a problem," he added. "There are always consequences [to new rules] but we would only be concerned if there were not enough stocks to settle the less than one percent of LME contracts that go to delivery."
The LME has always been aware that they may be unintended consequences when it has enacted reforms, Chamberlain said.
"There are things we would rather didn't happen but achieving the policy is the end goal and sometimes we have to accept that this might come with additional consequences," he said. "The important thing is that we as a market feel we have struck the correct balance."
Still, the exchange is at risk of over-extending its reach and is in danger of no longer reflecting a free market should it introduce these proposed measures, market participants have warned.
"The LME are bending over backwards to appease regulators and it will be at the detriment of the exchange," one said.
But the LME countered in the discussion paper that increased global scrutiny of the financial world make on overhaul of its regulatory regime necessary.
"As the LME's arrangements with its network of approved warehouses play an important role in the functioning of the LME's market and the trading of its contracts, the LME needs to be able to demonstrate that it has arrangements in place to ensure those warehouses operate in a way that ensures the LME continues to satisfy its regulatory obligations," it said.
And a free market does not mean an unregulated market, Chamberlain said.
"Rules are necessary as long as they are understood and they defend the orderly functioning of the market rather than undercut [it]," he said.
(Additional reporting by Archie Hunter, editing by Mark Shaw)