London 01/07/2013 - The London Metal Exchange will have the final say in proposed changes to its warehouse regulations even after starting a consultation period to tackle the issue of long queues.
The consultation period will last until September 30, with a final decision on whether to implement the changes expected at the scheduled board meeting in October.
The exchange is asking users "Is this a route you want to take?" chief operating officer Diarmuid O’Hegarty told journalists at a press conference today.
“[But] just as we have done with previous changes to warehouse agreement, we follow-up process but at the end of it is the LME decision on what to do,” he said.
“The board will have to use its judgement on not just what’s been said but who is saying it… [The LME is] interested in hearing from a broader spectrum - it will be a balance thing,” he added. "It’s not a numbers game - it’s a group of people that make a collective response. It’s the coherence of what people are saying that is important."
An outright rejection in the proposal, though, is unlikely to prompt the exchange to devise and offer further proposed changes to its current regulations.
“This is the proposal saying the potential things that the exchange might do, and this has flushed out, from the board's point of view, what is the most interesting of those. I think if market universally rejects this, then I suspect that would be it,” O’Hegarty said.
The “linked load-out/load-in rate” proposal, which only targets warehouses with queues of more than 100 calendar days, would force listed warehouse companies to deliver out at least as much metal as they deliver in, according to an LME notice.
In some cases, warehouse companies may even be asked to deliver out one-and-a-half times as much as they have delivered in, according to the exchange's complex proposals.
Under the terms of the proposal, all the metal loaded into a warehouse over a three-month period is measured; if there is a queue of more than 100 calendar days, the affected warehouse would be expected to deliver out additional metal based on a formula.
While the move would see a reduction in queues, there are potential repercussions. Warehouse rent is expected to increase - warehouse companies would continue to look to make a profit. The LME has factored this in - the proposed changes would come into effect on April 1 next year, the date for the next rent revisions.
At present, aluminium daily rents range from 29 to 48 cents per day for the 2013/2014 period. Apart from Japan stores, where no metal has been stored for several years and the rent is generally 29 cents, the lowest level is 35 cents in the BLG Cargo Logistics Store in Bremen, Germany.
In the locations where big queues have built up, Pacorini in Vlissingen has raised its rent to 48 cents from 45 cents. Metro in Detroit will also charge 48 cents, against 45 cents.
The LME has no power to control these rent increases and to set a cap on increases would be illegal.
“We cannot control who owns the warehouse companies and we cannot control the rent,” O’Hegarty said.
What effect this will have on overheads on warehouse companies and whether this would create upward pressure on rents are questions that the market must answer and decide if they can be comfortable with such changes, he added.
The implementation of the new regulations is complex; some warehousers may refuse to take in metal if this generates greater load-out requirements. Queues may initially become longer as warrant holders try to access metal and 100-day queues may become seen as “acceptable”.
Competition law limits the LME’s ability to act in certain respects and load-out requirements cannot be increased indefinitely, Matthew Chamberlain, head of strategy and implementation at the LME, said.
Only a small number of warehouses have queues and it would be disruptive to alter the entire network to solve problems at a small number of locations, he added.
“One hundred days is not a signal that 100 days is acceptable,” he said. “[The LME does not] see 100 days as stopping users getting metals; it’s that flip point between operational challenge and strategic threat.”
Additionally, the move could drive metal away from the LME warehousing system and into private storage.
“The balance of the two is hard to predict but that’s the feedback we are looking at,” O’Hegarty said.
The new proposal comes follows the acquisition of the LME by Hong Kong Exchange and Clearing (HKEx) at the end of last year. It was said members went back to basics to try to address the queue situation; it will now the market's turn to issue feedback.
“We don’t necessarily disagree with the consensus that queues are the result of macro-economic forces,” said HKEx CEO Charles Li in a blog entry today.
“However, as queues continue and even get worse in some cases, we want to take a fresh look at the issue. Therefore the LME Board has put forward a proposal that we believe balances the differing needs of LME members, warehouse operators and the metals industry,” he added.
The LME hopes to devise an alternative to the current arrangement that prevent queues from growing longer through introducing new load-out rates, reduce the length of the existing queues by applying new load-out rates for cancelled warrants “recycled back” to the queue and avoid penalising those who have invested and adopted business practices in reliance on previous LME rules through the grandfather provision, he said.
Li warned in October that he would solve the issue of long queues with a "bazooka "if necessary.
“Previously, I was quoted saying I would take a “bazooka” to the warehouse queue issue if getting access to metal were a big problem,” said Li. “But our assessment is that buyers have access, so we are not facing a fundamental problem with our market and a bazooka is unnecessary.”
Central banks have been flooding the market with money at near-zero interest rates, which means that the heavy oversupply of metal can be financed and stored with ease.
Warehouse firms, many owned by major banks and traders, are consequently able to pay high premiums to obtain metal, which then stacks up in stores, creating long queues and increasing overall rent income.
Queues have increased in Detroit, Vlissingen, New Orleans, Antwerp and Johor, where Glencore-owned Pacorini, Trafigura-owned Nems and Goldman Sachs-owned Metro are the dominant warehouse operators.
The queue to take delivery of aluminium from Detroit, for example, now stands at 16.5 months in the worse-case scenario under current LME rules.
(Editing by Mark Shaw)