London Metal Exchange (LME)

The London Metal Exchange (LME) is a premier futures exchange, actually the largest market for futures and options contracts in base metals. The LME offers cash trading and futures and options contracts with expiry dates of up to three months, along with longer contracts for up to 123 months. It also offers hedging with the option of settling contracts by physical delivery. It is also a major reference for metal pricing worldwide.

The LME is located in the City of London at 56 Leadenhall Street.

History

The LME was founded as the London Metal Market and Exchange Company in 1877, but its history goes back to 1571 when before the establishment of the Royal Exchange, traders conducted their business in the coffee houses of London using a ring drawn in chalk on the floor. The name ring trading probably stems from this practice.

Initially, only copper was traded. Lead and Zinc were added much later and their official trading status was granted only in 1920. World War II saw the closure of the LME, to be opened in 1952. Slowly and steadily, the exchange added other metals to its portfolio of offerings; aluminum in 1978, nickel in 1979, tin in 1989, aluminum alloy in 1992, steel in 2008 and cobalt and molybdenum in 2010.

The annual traded volume at LME hovers around US$ 11.6 trillion.

There is a history behind why many deals are for delivery after three months; in 1877 it took that long for copper cargo from Chile to reach England.

Metals Traded

LME is offers futures and options contracts in almost all the popular metals along with some minor ones. Metals traded on LME (in alphabetic order):

• Aluminum
• Aluminum alloy
• NASAAC (North American Special Aluminum Alloy)
• Cobalt
• Copper
• Lead
• Molybdenum
• Nickel
• Steel billet
• Tin
• Zinc

Operations

Any entity wishing to trade in a metal listed on the LME must do so through one of its members. After purchasing a contract, traders have to wait until maturity of the contract if they want to take delivery of the metal. If desired, they have the option to sell the contract before maturity. Upon maturity, the trader is issued a delivery warrant for taking delivery from any one of the approved warehouses.

To help traders make informed trading decisions, LME issues details regarding the quantity of each metal residing in its warehouses.

Ring Trading or Pit Trading or Open Outcry Trading

The LME is open for trading from 11:40 hours to 17:00 hours, London Time

The open outcry system of trading is the oldest and still relevant, rather essential, for price discovery, or the LME official price. The open outcry trading sessions, though short termed, are the most liquid periods of trading and also represent the best measure of demand and supply in the market. The official price at which trades are settled is the price at which a commodity is last offered before the closing bell is sounded.

Even though inter-office trading constantly occurs, a fair amount of trading is still done on the floor of the ring. Five minute sessions where each metal contract is traded in two blocks are held in morning and afternoon. Morning sessions start from 11:40 and lasts till 13:10 and afternoon session from 14:55 to 16:15, with a ten minute break in each session. The daily official exchange rates are settled in the second trading block in the morning.

After each block of official trading sessions, there are sessions of 85 minutes and 45 minutes of “kerb” trading. Trades in LME are in futures, options and in a form of Asian options known as TAPO or traded average price options.

Ring Members

Ring Dealing Members, who are also the members of the London Clearing House, hold exclusive rights for ring trading. Members are regulated by the Financial Services Authority. These include:

• Barclays Bank Plc
• Société Générale
• E D & F Man Capital Markets Limited
• J.P. Morgan Securities Ltd
• MAREX Financial Ltd
• Metdist Trading Ltd
• Natixis Commodity Markets Ltd
• INTL FCStone Europe Ltd
• Newedge Group (UK Branch)
• Sucden Financial Ltd
• Triland Metals Ltd
• Amalgamated Metal Trading Limited

Apart from these twelve Ring Dealing Members, nearly 100 other companies are also involved in the LME.

Precious Metals

Only base metals are traded in the LME. Precious metals such as gold and silver are not traded. Precious metals are traded in an over-the counter market commonly known as the London Bullion Market, (LBM) where the members of the London Bullion Market Association (LBMA) trade in gold and silver. Platinum and palladium have a separate market; the London Platinum and Palladium Market (LPPM). Members of both, bullion and platinum and palladium market associations, trade in the spot market of these precious metals on the Electronic Broking Systems (EBS), one of the many acquisitions of ICAP, a UK based money broker.

However, the London Metal Exchange does provide clearing services to LBM and distributes forward rates for gold and silver along with gold IRS (interest rate swaps).

Electronic Trading Platform

LME launched LME Select, its electronic trading platform in February 2001. Developed by Cinnober, a Swedish software company, it is a FIX-based platform that has been instrumental in shifting a significant amount of daily traded volume to electronic trading.

Physical Delivery and Hedging

Most of the contracts on LME are settled without actual physical delivery. Most players in the metal market use the LME for the purpose of hedging and managing their risks. However, as a last resort, the LME does offer an option of physical delivery in times of oversupply or shortage. Howsoever small the percentage of physical delivery trades may be, trades resulting in physical delivery play a crucial role in determining real price.

Warehouse

For supporting physical delivery, the London Metal Exchange has licensed warehouses and storage facilities at various locations all over the world. To maintain the high standard of service that the LME is known for, companies providing warehouse facilities must meet strict criteria before LME approves them for storing metals. Some of the major warehouse companies approved by LME include well known names such as Henry Bath, Pacorini Metals, Metro International Trade Services and Steinweg.