The London Metal Exchange is seeking agreement from its network of metal warehouse owners to cut the rents charged for storage, which could boost the amounts of metal registered under LME warrant and improve transparency. Rents for aluminium on warrant, which gives the material LME backing, currently averages around 54 U.S cents a tonne. Of that the exchange earns 1.1 percent. Rent for metal not under LME warrant is typically 10 cents or below.
"The LME has initiated a discussion with the warehouse community to find a solution to collectively cut the relatively high headline rents which can keep metal out of the LME network," a LME spokesperson said. LME warehouses over the last three years have been leaking metal, particularly aluminium where stocks at above 1.33 million tonnes are the lowest since Sept. 2008, before the financial crisis escalated, from above five million tonnes in 2014.
The drop is mainly due to reforms to reduce waiting times for consumers, which included a cap on warehouse rents. "People have a very clear incentive to keep metal off warrant," a warehousing source said. "Stocks should reflect an oversupplied or undersupplied market, but LME aluminium stocks are a percentage of the total."
Rent deals - where an owner gets a rebate if the metal is stored with a warehouse for a fixed period of time - often cut the cost of storing metal. However, sources say, LME rent somewhere around 20-25 cents could offset the need for these deals.
That level could also cut the costs of financing deals as LME metal is viewed by banks as good collateral. Financing deals involve buying metal with borrowed money and sold for a future date at a higher price. The difference between the two needs to cover the rent, the interest on the borrowed money and insurance and make a profit for the person behind the financing deal.
"About 50 percent of the aluminium under LME warrants is linked to some sort of financing deal," a metals broking source said. "At the moment lower rents would only work for aluminium." Aluminium has been the metal of choice for financing deals since the US Federal Reserve cut rates to historical lows near zero in December 2008, because of large surpluses in a market estimated at around 60 million tonnes.
Large global inventories of about 12 million tonnes also make aluminium a favourite for financing deals. Other markets such as copper and zinc are mostly balanced while those for lead, tin and nickel are too small. "Financing deals have been a feature of the market since 2008 because money was cheap," an investor source said. "For the LME it's a trade-off."
The LME and its parent Hong Kong Exchanges and Clearing may lose some revenue if rents come down, but that may be more than offset by the higher fees generated by rising volumes due to more metal being registered. LME trading volumes have been falling since January 2015 for reasons including a hefty 31 percent average trading fee hike, which persuaded many to go over-the-counter, and slow demand growth in top consumer China.
For aluminium, the damage was exacerbated by lower stocks. The reason being that all the aluminium in LME warehouses is owned by someone and if a company does not want to take delivery when the contract matures, it can sell and buy back for a future date. Frequently the trade of choice was tom/next - used to roll positions forward on a daily basis.
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