London 10/07/2015 - Litigation against the London Metal Exchange (LME) is "highly likely" should the exchange go ahead with a proposed cap on the rent charged for metal caught in queues, several warehousing sources told FastMarkets.
The LME has launched a market-wide consultation on recommendations to introduce queue-based rent caps (QBRC) as well as an increase in the minimum load-out rate for metal stored in exchange-approved warehouses.
But the exchange is over-extending its reach and could be in breach of anti-competition laws designed to ensure a level playing ground in an open-market economy, warehouse owners claimed. This legal hurdle has been a reason the exchange has not previously implemented such changes, they added.
"There is a very high probability of litigation either from a single warehouse or a group of warehouse owners. It is not a case of: 'Why would they [initiate legal proceedings against the exchange]?'; it is more: 'Why wouldn't they?'," a senior warehouse source said.
"The final situation will probably see the LME prevail but it would push [the introduction of the proposed changes] down the road a year or two," he added.
The LME has submitted its proposed consultation to intensive legal scrutiny to ensure that it could stand up in court, it said last week.
"We obviously can't rule it out but [we are] clear that the legal analysis is watertight," Matt Chamberlain, LME head of business development, said at a press conference here last Wednesday.
Under the new measures, warehouse companies that fail to deliver out metal held in queues within 30 calendar days would be required to halve the maximum published rent charged to the affected metal owners.
After 50 calendar days, no rent could be charged at all. This would remove any economic benefit for warehouse companies in maintaining a queue.
To ensure no warehouse company is unfairly disadvantaged, QBRC could be implemented on May 1 next year, the LME suggested.
The proposal is "basically a regurgitation" of regulations the CME Group has in place, sources claimed.
Under CME regulations, warehouses cannot continue to charge for storage for aluminium or zinc 20 business days after the metal is cancelled out - or five days for copper - provided that the delay was not caused by the warrant holder or the warrant holder's agent.
It can also forbid the warehouse from receiving more material until the late deliveries are resolved.
Many believe the LME is under pressure from the Commodity Futures Trading Commission (CFTC) to bring its regulations in line with US exchanges. The LME denies this, saying that the proposed changes are a direct response to long queues and are aimed at preventing from queues developing in the future.
Still, the LME has applied to become an official foreign board of trade (FBoT), which, while ensuring the LME would enjoy equal footing with US exchanges, also gives the CTFC more authority to investigate the LME's electronic trading and warehousing system.
Prior to 2011, foreign exchanges such as the LME operated in the US under no-action letter relief granted by the CTFC. But the Dodd-Frank Wall Street Reform and Consumer Protection Act strengthened the CFTC's hand in regulation and oversight of commodity market operations.
Under the FBoT application process, which started in 2012, the LME must prove that it possess all the attributes of an organised exchange, including rules that prohibit abusive trading practices and effective systems that promote financial integrity.
Warehouse operatives are concerned that the new measures would be open to abuse by incentivising metal holders to cancel metal to get it free of rent after June 2016.
If a customer requested a delivery of aluminium today, for example, that customer would most probably join the queue in Vlissingen and Detroit, which is currently just shorter than a year.
After May 2016, should the LME rule changes be implemented, the customer would be guaranteed a cut of half to the rent for his metal after 30 days and have it free of rent after 50 days.
"Big cancellations will now take place to extend the queue before the new regulations come in," a second warehouse source warned.
But there are rules in place prohibiting any such moves, which would be seen as abuse, the LME said.
"We have the right to dis-apply QBRC if it is abused and would not hesitate - warehouses shouldn't be concerned that they will be a victim of attack from metal owners creating queues and getting free storage," Chamberlain said.
The warehouse itself would be responsible for reporting the abuse to the exchange, FastMarkets understands.
As yet, there have been no major swings in cancellations - in aluminium, for example, cancelled warrants fell a characteristic 7,665 tonnes to 1,540,550 tonnes, according to today's inventory data. Total stocks now stand at 3,539,500 tonnes, of which Vlissingen holds 1,749,325 tonnes and Detroit 596,350 tonnes.
(Additional reporting by Tom Jennemann, editing by Mark Shaw)