The London Metal Exchange (LME)
About the Exchange
The London Metal Exchange is the world's premier non-ferrous metals market with highly liquid contracts and a worldwide reputation. It is innovative while maintaining its traditional strengths and remains close to its core users by ensuring its contracts continue to meet the high expectations of industry. As a result, it is highly successful with a turnover in excess of US$4,500 billion per annum. It also contributes to the UK’s invisible earnings to the sum of more than GBP 250 million in overseas earnings each year.
On an international scale the London Metal Exchange is one of the City of London's most influential institutions. It is not widely known to the general public but it is appreciated and respected by the global mining, metals and financial communities because it provides essential services that play a part in maintaining the stability of commodity prices throughout the world.
The LME is one of the leading international commodity, futures and options exchanges. It specialises in nonferrous metals - Copper, Primary Aluminium, Lead, Zinc, Nickel, Tin, Aluminium Alloy, Silver and an index contract - LMEX, which tracks the six primary metals traded.
International trade in metals could be said to have commenced in Britain when the Romans invaded in AD43 and extracted the large deposits of copper and tin ore in Cornwall and Wales to satisfy their increasing domestic need for the production of bronze and alloys. However, the origins of the London Metal Exchange can only be traced back as far as the opening of the Royal Exchange in London in 1571 during the reign of Queen Elizabeth I. It was there that traders in metal and a range of other commodities began to meet on a regular basis. At first the traders merely dealt in physical metal for the domestic market but because Britain soon became a major exporter of metals, European merchants arrived to join in these activities.
In the early 19th century there were so many commodity traders, ship charterers and financiers using the Royal Exchange that it became impossible to do business and individual groups of traders set up shop in the nearby city coffee houses. The Jerusalem Coffee House off Cornhill became a favourite of the metal trading community. There the tradition of the Ring was born. A merchant with metal to sell would draw a circle in the sawdust on the floor and call out 'Change' at which point all those wishing to trade would assemble around the circle and make their bids.
In the early part of the 19th century the U.K. was self sufficient in copper and tin and quoted prices remained fixed for long periods. Everything changed with the advent of the Industrial Revolution when, almost overnight, the U.K. became the most technologically advanced country in the world, importing large tonnage's from abroad.
The metal traders were now faced with a real problem because, having bought ores and concentrates from as far away as Chile and Malaya, they had no way of knowing what the price would be at the time of the ships arrival some months later. The import of large tonnages from overseas at irregular intervals put merchants and consumers seriously at risk. Technology came to their aid with the invention of the telegraph.
Inter continental lines of communication were established between the countries of the world and the change from sail to steam ships made arrival dates more predictable. Now merchants were able to anticipate the time of arrival of a cargo of metal and were able to sell it forward for delivery on a fixed date, thus protecting themselves against a fall in price during the voyage.
In 1869 the opening of the Suez Canal reduced the delivery time of tin from Malaya to match the three months delivery time for copper from Chile and this gave rise to LME's unique system of daily trading dates for up to three months forward which still exists to this day. As delivery tonnages grew to meet the increasing demands of British industry, more and more merchants were attracted to the trade and it became necessary to find premises where they could convene each day. They first moved to the Lombard Exchange and Newsroom but once again the intrusion of other traders drove them to find new premises.
In 1877 they formed the London Metal Exchange Company and moved into their first premises over a hat shop in Lombard Court. Telegraphic links were set up and a company secretary was appointed to handle the administration. Membership increased rapidly and, after surpassing the three hundred mark, the decision was taken to move to a purpose built Exchange in Whittington Avenue, where it remained for 98 years. Then, after a period of 14 years at Plantation House in Fenchurch Street, the Exchange moved in 1994 to its current, prestigious home in Leadenhall Street.
Throughout its history the LME flourished, though never more so than today in terms of trading volume. The world of metals and base metal trading has changed dramatically over the last century, the LME continually adapting to these changes. New metals have been introduced as demand dictated. Copper and tin have traded on the LME since the beginning. The copper contract was upgraded to high grade copper in November 1981 and again to today's Grade-A contract which began trading in June 1986. Tin's present (99.85%) contract began in June 1989, following a brief cessation due to the collapse of the International Tin Council. Lead and zinc were officially introduced in 1920, but were traded unofficially before that. The lead contract has remained virtually unchanged, certainly since its reintroduction in October 1952 following the closure of the Exchange brought about by the second World War. Zinc, on the other hand, has undergone a number of upgradings, most recently with the introduction of the special high grade 99.995% contract in June 1986. Primary aluminium was introduced as a 99.50% contract in December 1978 and today's 99.7% high grade contract began trading in August 1987. Nickel commenced trading on the Exchange the year after primary aluminium, in April 1979, aluminium alloy in October 1992 and in May 1999, a silver contract was launched.
An index contract -LMEX- based on the six primary metals traded on the exchange was introduced on the 10 April 2000. This base metals index is specifically designed to provide investors access to futures and traded options contracts based on non-ferous metals without the physically delivery, storage and transactions costs associated with the underlying commodity contracts.
London Metal Exchange functions
The London Metal Exchange provides the global forum for all those who wish to manage the risk of future price movements in non-ferrous metals and plastics. The Exchange has developed standardised contracts which assume that on falling due they will result in material either being delivered or received.
Brands of material that meet rigorous quality standards are stored in approved warehouses around the world so that material can change hands - but in reality most contracts are settled out without that taking place.
All the trading associated with the Exchange means that the market is highly liquid, transparent and the prices published are seen as a true reflection of demand and supply by trade and industry. The LME provides an outstanding service to industry through its activities, and has a great responsibility because of its pre-eminence in this field. We are proud of our regulatory standards, which promote further confidence in what we do.
Trading on the LME
There are currently three ways to trade on the LME.
Trading in the Ring. Ring trading is so called because the LME uses a "ring" with the traders sitting at fixed points around the circle. Trading takes place throughout the day with each LME contract traded in specific five minute periods known as "rings".
The LME system of fixed points clearly helps with the identification of the firms trading, but it is only feasible because the Exchange has a small number of members permitted to take part in ring trading. At present there are 11 “ring dealers”, and all business which is required to be dealt “across the floor” must be passed through a ring dealing member.
A significant proportion of all LME contracts are traded in the ring sessions, including the kerb, or as a result of that trading. The balance goes through the inter-office telephone market and LME Select.
The ring sessions, and especially the second morning rings from which official prices emerge, concentrate liquidity because the physical trade requires prices as close as possible to the daily and monthly settlement prices. This concentration of liquidity ensures both transparency of pricing, and more representative prices than may be obtained through inter-office trading.
The ring itself is about 6m in diameter, with two large display boards above it showing the official prices. There is a special booth where the Exchange’s staff monitor the prices and input bids, offers, spreads and trades made into a computer system. This is instantly sent to the various news vendor services, who display LME prices. Behind each firm’s ring seat is a place for assistants to stand in order to pass orders into the ring and to give commentaries to customers about current market conditions.
Trading on the inter-office telephone market. The ring offers the traditional benefits of transparency attached to a physical, open outcry marketplace, but it is only available for a part of the 24 hour working day. A modern financial market needs to be able to service the needs of its customers for all of the working day, if not longer, and so the LME accommodates this by inter-office trading.
This is a system that deals like the foreign exchange, bond or stock markets, but then clears like a ring-traded contract. In other words, people can see an indicative price on a screen as they contact a broker, and then complete a deal there and then.
Brokers continue to provide indicative prices which are available through vendor screens. The actual prices quoted to a prospective client by a broker will not necessarily be identical to the indicative prices, but will depend on the size of the deal, the state of the market, and on the client’s credit rating and relationship with the broker.
If a broker’s quotes are noticeably out of line with the indicative prices on the screen he is likely to lose business. It is in the firm’s own interest to ensure that the prices on the screen are kept up-to-date, especially in fast moving markets.
Transactions done through the inter-office trading system are “real” LME contracts and pass on through the matching, clearing and settlements procedures.
LME Select Screen Trading System. LME Select is the official exchange operated electronic trading platform, available in addition to open outcry ring trading and the telephone market.
Member firms are connected to the system which allows accredited traders to execute trades electronically.
Flexibility and functionality are the key words associated with this system. Flexibility, in that the system allows traders a wide range of preferences for setting screens tailor made for their individual needs. Functionality, in that the basic screens required for trading are supported by a number of screens giving in-depth analysis of the market and executed trades.
The system allows trading on all LME contracts, futures, options, traded average price options (TAPOs) and carries. It will also allow for straight through processing whereby LME Select trades will automatically be sent to the matching and clearing systems operated by the LCH.Clearnet. LME Select operates between 01:00 and 19:00 (London Time).
Source - London Metal Exchange