The way U.S. commodities exchanges are dealing with warehouses could offer a template for the London Metal Exchange (LME) to reform its chronically logjammed storage system, the backbone of the world’s biggest metals marketplace.
But this route to reform could prove difficult, not least because competition law in Europe may rule out solutions that are acceptable in the United States.
A London High Court judge last month quashed a key part of the LME’s long-awaited plan to shorten the queues that users of aluminium can face to withdraw metal, which they have bought via the exchange, out of warehouses that the LME oversees.
Big banks and trade houses that own many of the warehouses in the global network, and charge rent on the stored metal, have profited from letting companies such as drinks can makers wait for months or longer to get hold of the raw material they need.
After a tough, divisive consultation among stakeholders, the LME, which is owned by Hong Kong Exchanges and Clearing had been poised this month to act on the issue.
But the court upheld an objection from aluminium producer Rusal, saying the LME consultation process was “unfair and unlawful” as it presented only one viable option: reduce queues by limiting how much can be brought in and out each day.
The judge said the LME should have publicly considered another alternative that it and many experts said repeatedly would be deemed anti-competitive: banning or capping rent that warehouse operators charge on metal sitting in queues.
The ruling handed an opportunity to CME Group, which is launching a challenge to the LME’s aluminium contract.
Mindful of problems plaguing the LME, CME has imposed rules that will prevent warehousing companies from profiting unduly from long queues and lucrative rents.
CME director of metals research Young-Jin Chang told a recent conference in the United States that the exchange would be prepared to intervene to deal with queues longer than 20 days, according to delegates at the conference.
It would first tell the warehouse it cannot charge rent on the portion of metal that is late. And if CME needs to take further action, the exchange could forbid the facility from accepting more metal until the late deliveries are resolved.
The CME is finalising its rules ahead of launch on May 5, and being ready to clamp down on long wait times will be crucial for the contract’s success, market participants have said.
For copper in CME warehouses, if deliveries go beyond five days the exchange has a right to tell the warehouse to stop loading in metal.
Rusal, which has indicated that it might eventually fall into line with the LME’s plan, endorsed CME’s approach.
“I’m familiar with structures on the COMEX exchange. I think something of that type could work very well but it’s really a question for the LME, not Rusal,” said Steve Hodgson, Rusal’s sales and marketing director.
The U.S. Commodity Exchange Act, which regulates commodities markets, restricts clearing houses and exchanges from adopting rules that could result in unreasonable restraint to trade or impose a material anti-competitive burden.
But exchanges could impose major changes, such as on rent charges, if it was considered necessary to keep trade orderly.
A U.S. antitrust lawyer said changes could be implemented if they were “necessary to achieve the purposes of the Act”.
“That’s baked into U.S. law,” said the lawyer, who did not want to be named.
Intercontinental Exchange stepped in quickly when some traders and warehouses in cocoa and coffee, seeing how the practices adopted in metals gave players a competitive edge, started looking at the viability of building lucrative queues.
ICE brought in new rules, which became effective on April 1, forcing warehouses to stop charging rent for goods that have not been moved within 60 days after a request is made and require additional information to justify warehouse charges.
The changes followed ICE’s acquisition of NYSE Liffe, including the London-based cocoa and robusta coffee contracts in November, and aligned Liffe’s grading and warehouse keeping procedures with those of ICE.
But, encouraged by the court ruling against the LME, European coffee and cocoa warehouse companies plan to seek legal advice on ICE’s new rules.
While that law sets the standards for U.S. commodity markets, if a U.S. exchange has a subsidiary in Europe which is registered as a derivatives clearing organization (DCO) or a registered clearing house (RCH), then the rules are less clear.
“If it’s ICE Europe and it’s registered as a DCO or an RCH, there’s some ambiguity as to where the line is. If it’s a European exchange or clearing house, it would be a European matter,” the lawyer said.
So the European coffee and cocoa warehouse companies could have a case, and this also highlights the LME’s dilemma.
A blanket global rule on rents would not work.
“In general the U.S. can take a slightly more liberal view on vertical pricing matters, so they take a rule of reason approach to a greater degree than the European Commission typically does,” said James Marshall, a senior associate at law firm Berwin Leighton Paisner LLP.
COMPETITION LAW OBSTACLE
In Europe, one of the LME’s key concerns is probably that banning or influencing rents would be seen as a form of “resale price maintenance” which will nearly always breach European competition law, Marshall said.
Effectively this means the LME cannot interfere in warehouse rent-setting because companies need to be able to set their prices independently.
The LME has said it is unable to comment on the legal advice it is receiving.
The other big issue is the LME’s unique position as the key metals trading platform for global price setting - it also handles metals including copper, nickel, zinc, lead and tin.
“That level of importance restricts the LME’s ability to implement new pricing initiatives because that again raises a number of competition issues,” Marshall said.
“But it’s not an entirely open and shut case where you can say, yes ‘you definitely can or can’t do it’, there’s not always a black line here. Unfortunately it can be a gray area.”
There may well be very good reasons for capping or banning rents, but any pro-competitive and pro-consumer benefits would need to outweigh any potential detriment to competition.
“There may be ways you can get around the prohibitions if there are very good reasons to do so, but that’s the kind of thing that has to assessed on a case by case and granular basis,” Marshall said.
“It’s a complicated issue to look at in isolation, and it could take a lot of time and analysis to get to the answer.”
February 19, 2015
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