Winter Park, Florida 21/11/2014 - The London Metal Exchange intends to amend its warehousing rules so that operators will no longer be able to inflate queues artificially by shuffling metal between its sheds.
As part of a two-year investigation, the influential US Senate Permanent Subcommittee on Investigations found that Goldman Sachs, via its warehousing subsidiary, Metro International Trade Services, paid incentives to metal holders to move metal on and off warrant in what is now being called a 'merry-go-round' trade.
Metro ultimately entered in six so-call merry-go-round deals with Deutsche Bank, Glencore and UK hedge fund Red Kite.
In each deal, Metro provided financial incentives to the owner of the aluminium stored in its warehouses to: wait in the queue; upon reaching the head of the queue, load out its metal from a Metro warehouse; deliver the metal to another nearby Metro warehouse; and warrant the metal while in the second Metro warehouse.
The Senate Subcommittee asked the LME if it considers it a violation of its load-out rules for an owner of multiple warehouses to load out metal from one warehouse only to load it back into another warehouse owned by the same company in the same geographic region.
Without addressing any specific conduct, the LME via a correspondence by Sean Berkowitz of law firm Lantham & Watkins answered the Subcommittee's question on a hypothetical basis.
“In short, while the LME would view such behaviour as a contravention of the 'spirit' of the relevant requirements, it may be difficult to argue that it constitutes a contravention of the 'letter' of those requirements,” Berkowitz said on behalf of the LME.
Clause 4.2 of the current version of the LME Warehouse Agreement states that: “A warehouse is required to expedite delivery from the warehouse at the minimum rates published from time to time by the exchange.”
But neither the warehouse agreement nor the policy on approval of warehouses defines the term “delivery from warehouses” or “delivery out”.
“When the warehouse agreement and the policy on approval of warehouses were originally drafted, conduct such as that which you describe was not anticipated. Accordingly, the draftsman did not consider it necessary to further define what was meant by 'delivery from warehouse',” Berkowitz said.
“In the LME's view, the words should be arguably be given the ordinary meaning, implying that the metal should leave the premises of the warehouse company,” he added.
“However, in the scenario you describe, the material would be paced on a truck and would leave the shed of the warehouse company, albeit to return to another shed owned by the same owner at a later data. The LME would not have visibility as to what happens to the metal once its cancelled and delivered out the warehouse,” he added.
While on warrant, the metal has an identifier number and is tracked within LMEsword. The LME also has visibility of cancelled stock - warehouse companies are required to report cancelled stock to the LME.
“Once it is delivered out of the warehouse, however, the LME has no further visibility of that metal. The metal has arguably left the premises of the warehouse company,” Berkowitz explained.
The LME has, however, engaged in two separate consultations to examine rule changes specifically designed to address this behaviour. Specifically, if the new language is approved, a load-out will have to be accompanied by a bill of lading to certify that metal is not being moved to another nearby warehouse owned by the same company.
It is broadly anticipated that these new changes will be in place by June 2015, Berkowitz said.
The LME was also specifically asked if it considers what Metro did to be consistent with the LME rules and if the LME intends to take any action against Metro.
While the exchange answered that question, as an instrumentality of the government of the UK and as a market regulator the LME maintains strict confidentiality of continuing investigations; its answer was therefore redacted by the Senate Subcommittee.
(Editing by Mark Shaw)