In my blog last week, I talked about our plan to build out the ‘East Wing’ of the London Metal Exchange (LME) business here in Asia. And just today, we are delighted to announce one of these ‘renovations’ – an improvement in the way the LME’s Asian Benchmark Price is determined. We hope that changes like this will make the LME more accessible to our ‘guests’ from China and other parts of Asia, and I’d like to explain to you what the changes to the benchmark are about and why we’re making them.
One of the driving forces behind our acquisition of the LME is the growing relevance that Asia, and particularly China, has in global commodity markets. Even though the LME operates in London in an entirely different time zone, Asian trading on the bourse - through its 18-hour electronic trading system - has been increasing year-on-year. With greater trading volume from Asia comes greater need for Asian dynamics to be reflected in the price discovery in that time zone. It is for this reason that we have come to focus on the Asian Benchmark Price. But before I get into details, let me first provide some background on the ‘pricing of commodities’ on the LME, which is a relatively new topic in Hong Kong.
The LME is the world’s leading price formation venue for base metals, with more than 80 per cent market share of global non-ferrous metals futures trading on its platforms. Pricing metals is at the core of what the LME does. The key benchmark prices, including the LME Official Prices and LME Closing Prices, are ‘discovered’ through buying and selling on the Ring, the open-outcry trading floor in London, at set points throughout the day. Open-outcry sessions in the Ring have a long and storied history, dating back to 1877, and still attracting vigorous trading to this day.
The prices ‘discovered’ on the LME’s platforms are used as the global benchmark and basis for physical trading as well as in the valuation of portfolios, in commodity indices, and in metal ETFs. The price of the aluminum used to construct your iPad or the copper in the wire inside your home was very likely based on the price discovered on the LME. The LME’s global network of licensed warehouses helps ensure that its prices reflect the reality of supply and demand on the ground.
While this benchmark pricing system has worked for generations and continues to work well, the rise of China as the world’s second largest economy has created a vast new market for metals. Today, China is the world’s biggest producer and consumer of non-ferrous metals, accounting for about 40 per cent of the global total. This, together with the market growth in other parts of Asia, has direct impact on LME trading patterns. Over the past few years, trading on LMEselect, the LME’s electronic trading system, has been increasing in the Asian time zones, which is early morning in London. In 2010, trading on LMEselect before 7 am London time, the afternoon in Asia, doubled from the year before, prompting the LME to launch its Asian Benchmark Price for LME Aluminum, LME Copper and LME Zinc to enhance its market for LME users in Asia. Alongside the global LME price, we believe the Asian Benchmark Price could more accurately reflect the supply and demand of metals in the Asian time zones. In 2012, three-month futures trading on LMEselect in Asian time zones increased by another 13 per cent year-on-year, leading to today’s announcement.
The announced improvement is two-fold. Firstly, the timing of the publication of the LME Asian Benchmark Price will be adjusted to the closing of other key commodity futures markets in Asia. Secondly, the LME will improve the Asian Benchmark discovery process by reducing the pricing window from 15 minutes to a new five-minute pricing window, thus focusing liquidity into a shorter trading period.
The effectiveness of the LME Asian Benchmark will become more meaningful over time as the LME gets more traction with wholesale customers in China, who are increasingly exposed to international price risk through the import of base metals, in conjunction with an expected increase in LME membership from Asia. Further, as we look to develop new products tailored to Asian users, the products could be benchmarked or settled against the LME Asian Benchmark. This is all part of polishing up the ‘East Wing’ of the LME’s business to make it more attractive to Asian users.
The enhancement of the LME Asian Benchmark is just one step the LME is taking in Asia. Over the coming months and years, we will be working with the LME and its users to grow their business further in China and the rest of Asia, finding new ways to capture the huge surge of physical trading and hedging of metals in the region.
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