London 28/07/2016 - The decline in short-dated carry trades on the London Metal Exchange (LME) has clearly been felt in the aluminium 'Tom'/next (tomorrow/next day) market where average daily volume (ADV) has declined to the lowest since at least 2007.
Traders now hope the exchange will implement concessions to boost the once actively traded Tom/next spread.
The LME has attributed the drop in ADV to below levels even during the 2008 financial crisis predominantly to falling warehouse inventories - aluminium stocks are at 2008 lows following a spate of new regulations.
"I would say that the 'Tom'/next volumes are a percentage for warehouse stocks, a percentage for the actual type of trading and a percentage, of course, of the fees - if its free, you are going to get higher volumes," LME CEO Garry Jones said during LME Asia.
But traders have blamed last year's fee increases following a takeover by the Hong Kong Exchange & Clearing (HKEX).
Carry trades were always the most at risk because they are hit on both legs; fees here were raised to $5.40 from $3.75. Since some traders would roll positions on a daily basis of various lots sizes, the increase soon starts to tally up.
"For some companies the 'Tom'/next trade made up a large proportion of their business model. The extra costs here have made it impossible and so it is not surprising that there has been a decline in volume," a category one trader said.
HKEX CEO Charles Li told delegates at LME Asia that it might re-examine fees but did not give any further details.
"We stated during LME Week Asia that we were open to discussion with members on this among other issues and these discussions are ongoing," an LME representative told FastMarkets on Thursday.
All market participants with whom FastMarkets has spoken said they hoped that carries would benefit from any reshuffle.
"The carries are a big deal for the LME industry and the increase in fees has clearly had an impact. Sometimes it is better to admit that something hasn't worked and go back to how it was than ploughing on regardless and killing the system," a senior member said.
Aluminium is now showing one of the clearest trends of longer rolls; one impact has been fewer trades. For aluminium, outrights now account for more than 40 percent of total volume.
"Traders are lending out further and not doing short-dated carries - this becomes instrumental in its own disaster as the spreads were what made LME work," a broker said.
"The LME aluminium contract is starting to look shaky - so much was done in spreads and this part is dying," a second category one member said.
The argument that fees were too cheap with and needed an increase was "counter-intuitive", another stated.
"There is not as much liquidity on these dates and the old mantra of lend long and borrow short no longer plays out as people do not want to roll day-by-day," a third category one said.
"Previously, several traders would be happy to use the 'Tom'/next to roll as it would typically be a better trade than if you did it by the month. But as there's a fee each time you roll that position, well, you wouldn't want to do that now," he added.
The exchange is under pressure because of falling volumes - across all complex, these fell 7.8 percent in the first half the first half of 2016 fell 7.8 percent. While the exchange attributed this to a decline in physical trading, traders again said that higher fees were the main factor, having previous forecast volumes to fall after the "unprecedented" rate hike.
"It is not the members who are not using the LME - it is our clients. I spend a lot if my time talking to clients who are simply not interested in the LME as they say it is too expensive. The argument that members are just bitter about fee hikes after we sold the exchange doesn't hold ground if it is the clients who are turning their backs," the senior member said.
Meanwhile, the mooted rival members-backed platform - lead by former LME CEO Martin Abbott - highlights the extent of the frustration felt by some. Several members have become disenchanted with the alterations made by the LME that allow direct access and incentives on monthly prompt and "third Wednesday" contracts.
"The LME say they are listening to their members and I think [lower short-dated carry fees] would go some way to proving that is the case and nip all the backbiting and revolts in the bud," the senior member said.
"I am not anti-LME. I do not wish for it to fail, especially as a notable chunk of my business is done through the exchange, but business is suffering because of the fees. A shift towards OTC and talk of new platforms shows the discontent. Something needs to change sharpish for members to re-align with the exchange," a second senior member said.
(Editing by Mark Shaw)