London 29/09/2016 - The London Metal Exchange fully understands that some market participants see its new warehouse regulations as too complex but it also worries that future attempts to streamline them might muddy the waters even more.
Following the purchase of the LME by Hong Kong Exchange & Clearing (HKEX), the exchange carried out a 12-step reform to reduce queues at LME sheds. Of these, queue-based rent caps (QBRC) resulted in the loudest dissent both before and after implementation.
Participants highlighted mass delistings, flare-ups along the forward curves, declining volumes and confusion about calculations - there is talk that some traders have been badly burnt by the complexity - as reasons why simplification is needed.
While the exchange expected "unintended consequence" from the measures, sources said that the LME was unsettled by the extent, prompting speculation that the it could simplify them to help stem the confusion.
"The exchange sees that the measures were too complicated. It has been discussed but it will be six months of discussion and six months of implementation - so we are looking at least a year until something can be done," a warehouse source said last week.
But a consultation published yesterday suggested that it is unlikely to make changes only for simplicity's sake. While the LME agreed "with the principle of simplicity", it said the very process of attempted rule simplification would "itself represent a further complication to the network".
"The LME notes the desire amongst certain parties for rule simplification. However, the LME also notes the view, expressed to the LME by certain stakeholders, that the simplest approach would be to leave the rules unchanged for a period of time," it said
One respondent, who was not named, asked the LME to reconsider the QBRC's "flaws" and to incorporate a more appropriate structure of reduced rates.
It asked that the LME should not view its previous reform as "fixed and immutable" but should instead "reassess and redefine its approach to promote simplification which would ultimately serve the interests of the LME and the market".
But the feeling at the exchange is to leave things unchanged - the expectation is that falling warehouse queues will resolve most of these issues, FastMarkets understands.
If the entire market were to deem the rules too complicated, the exchange might consider a review but it will stand pat for now.
The QBRC rule compels a warehouse to halve the daily rent it charges after 30 days of waiting time and not to charge rent at all after 50 days. And it has worked in that queues have fallen.
But volumes have also fallen - total aluminium volumes in the first eight months was down 11 percent compared with the same 2015 period. Open interest in aluminium was down close to one million contracts.
And as the supply of deliverable warrants has fallen, volatility around the front end of the curves has increased - the warehouse reforms have been driving metal out of those queued warehouses.
At the Metal Bulletin aluminium conference in Madrid, LME business development manager Matt Chamberlain said there was a strong correlation between queues and long-term contango. Additionally, there has been more backwardations since it took action against queues as there are fewer warrants for liquidity.
"But now we have five percent of warrants in non-queued locations, 95 percent in Access World. In the past, 100 percent was in Access World - it is better," he said.
Access World - formally Pacorini - was the only warehouser directly affected by QBRC. Since the rule change came into force on May 1, it has seen a continued drawdown in inventories. Aluminium stocks at its Vlissingen warehouse now stand at 553,900 tonnes compared with 1,082,750 tonnes at the start of May and 1,249,050 tonnes at the start of the year.
Cancelled warrants, meanwhile, are also lower at 499,275 tonnes against 832,550 tonnes at the start of May.
Should there be a simplification, there are concerns that Access World might consider legal action, sources told FastMarkets.
Following the news yesterday that the exchange would press ahead with charge capping measures, the exchange stated this brought an end to the recent run of reforms. Since the warehouse reform, nine new warehouses have joined and only two left, the LME added.
(Additional reporting by Perrine Faye, editing by Mark Shaw)