London 14/07/2016 - The London Metal Exchange (LME) is not expected to push ahead with changes to its FOT regulations because these would be too disruptive to the market, sources told FastMarkets.
In April the exchange put forward for discussion a series of measures aimed at ending ever-increasing warehouse rent and FOT rates, which it deemed out of line with the economic cost. Initial charge increases submitted this year averaged 10 percent for rent and 12 percent for FOT.
Recent talks had convinced participants that the FOT change - one of the most contentious issues in the discussion paper - had lost support, sources claimed.
"I don't think the ideas on moving to an FOT contract will come to anything," a well-placed source said.
A second source said FOTC appears to "off the table" due to logistical issues.
"It would be a huge undertaking and we were lead to believe there was no appetite for it. Possibly the trade would like it but it certainly didn't seem to be a priority for the exchange," a third said.
FOT Conversion (FOTC) is the conversion of the LME contract from an "in warehouse" contract (where the buyer pays the FOT charge) to an "FOT-paid" contract (seller pays FOT).
This rules out an "exit charge" whereby those purchasing the metal are subjected to high FOT rates that they had not been able to negotiate.
The simplest FOTC method would be for the LME to set a start date beyond the maturity of the longest-dated contract. But the aluminium and copper contracts can have maturities up to 123 months forward, meaning it would more than a decade before it could be rolled out.
Another possibility is a "big bang" introduction in which the LME selects a date beyond which all LME contracts would be settled on a FOT-paid basis. But, again, there are hurdles.
Because open interest would already exist beyond this date, it would be necessary to adjust all positions already open on the market with a "universal rate". Deriving this rate would be complicated and contentious.
This is not the first time such a proposal had been explored. In 2007 the LME - then a membership-owned entity - ran an independent review into its feasibility but dismissed it as "not in the best interest of the exchange or the wider metals industry".
"Following talks with the exchange, that was certainly the flavour a lot of participants walked away with - it had been mooted before and turned down. I think the inclusion in the discussion paper was to just show every route had been looked at," a fourth said.
Charge capping (CC) was also up for discussion as part of the warehouse review
The exchange expressed disappointment that warehouse operators did not make larger cuts to their proposed 2016-2017 fee increases after it provided a two-week window for changes - only Metro and Istim, which had previously proposed the highest rate rises, revised them lower.
It outlined four ways in which CC levels could be set: via an inflationary adjustment, a charge freeze, a transitional floor or an immediate rate reduction.
Of these, the latter two are unlikely because of the legal implications, sources told FastMarkets.
"I do not think they will go with a violent reduction. In my opinion the only one in the running is an average but it is unclear if this would be using 2015 or 2016 numbers," the second source said.
Rates could fall back to 2015 levels and would not be followed by increases for some time, another suggested.
Under the first two approaches, warehouses would not generally be expected to lose money in respect of incentives paid, the LME said in the paper.
The exchange is expected to publish the results of its discussion paper shortly following a period of discussions both internally and externally.
(Editing by Mark Shaw)