London 22/07/2013 - The Federal Reserve announcement on July 19 and the Senate Banking Committee hearing on July 22 mark the “beginning of the end for the warehousing issue and may have far more painful implications for the banks in the future,” said Nick Madden, senior vice president and chief supply chain officer at Novelis.
A US Senate committee has scheduled a hearing for tomorrow to question witnesses about bank ownership warehouses and refineries.
Additionally, there have been reports that the US central bank is reviewing a 2003 precedent that let deposit-taking banks trade physical commodities.
Furthermore, Reuters reported that the CFTC has put some banks and selected traders that it wants them to preserve any communications related to incentives or other related delivery procedures - although at this stage, the CFTC has not launched a formal probe.
“It didn’t have to come this far if the LME had acted more seriously two years ago when presented with the potential risks and obvious solutions,” added Madden in his blog on Monday.
“The ultimate solution is either to increase the scope of regulation or prohibit these financial institutions from participating in unregulated markets in the first place. It seems very severe and would have a detrimental impact, not just on the banks but also on other market participants who benefit from the more benign banking activities in the physical market such as financing, consigning stock and making premium markets, for example.”
Metals market participants over the past several years have taken advantage of a sizeable contango, cheap rents and historically low interest rates to cover the cost of storage, insurance and financing of their inventories.
It's also no coincidence that that big-name banks and financial traders started collecting warehouses to take advantage of these profitable transactions.
But because of the overwhelming popularly of these deals, millions of tonnes of metal have piled up in LME warehouses, while physical aluminium premiums have spiked to all-time record highs.
Consumers, such as aluminium can makers and downstream fabrications, believe the warehouse bottlenecks grossly distorts supply/demand fundamentals and are not part of healthy markets.
Meanwhile, the London Metal Exchange (LME) hopes to reduce lines by making warehouse companies with sheds where waits exceed 100 days deliver out up to one-and-a-half times more metal than they take in.
The consultation period will last until September 30, with a final decision on whether to implement the changes expected in October.
“Novelis will propose and aggressively advocate its ideas to the LME in the coming weeks as part of the ongoing consultation process,” added the blog.
This latest proposal could shift the market in the right direction, said Madden, as it would dampen the appetite of LME warehouse owners to bid for metal and should begin to normalise local market premiums, but it is complex and will be difficult to administer and enforce.
But, the blog added the LME could have gone further and moved faster in its latest proposal. It suggested a more direct approach would have been to ban warehouses from charging rent a month after the buyer has asked to collect it from the warehouse, or create a more direct linkage between stocks held and the load-out requirement
The real issue is that no matter what the LME does, some market participants may find gaps and loopholes in any new proposal and can combine their levers to generate value for themselves at the expense of others, added the blog.
“And why can they do this? Gaps in the regulatory framework exist today. Novelis and others have been in talks with regulators on both sides of the Atlantic in recent months and my conclusion is that warehousing and more broadly, commodities, are outside the normal scope of these regulator,” Madden said. “This is why the LME has such difficulties in finding a solution to this challenging issue. In this under-regulated market, the players with all the levers have too many opportunities to generate value for themselves.”
(Additional reporting by Tom Jennemann)