At the Heart of Base Metals

Well, good evening, Patrick. Really great to see you and thanks for the invitation. I'm actually in Milan, which explains the rather Italian hotel room. This is not what my house looks like, sadly, but I'm down here to take part in a few of the discussions for the pre-COP meetings before the COP Summit in Glasgow. So, always fantastic to be in Italy.

Glasgow for the finals. You know, I've really enjoyed being part of the sustainability community, for want of a better word, perhaps an honorary member of the sustainability community because there's a lot of people who've done an awful lot more work and are much more experienced than we are at the LME. But it is fascinating to see how these processes develop and the great amount of work and good intention that go into hopefully a successful conference or meeting, as will be the case in Glasgow.

Yeah, absolutely. Like all markets, we have evolved and adapted. We're really sitting here today on the back of a huge amount of work that's been done ever since the formation of the LME, and that's traced the technological evolution of metals. When the LME was founded back in 1877, we really only had copper and tin because they were the common metals. Aluminium, I always like to remind people, was a semi-precious metal in 1877, and so we didn't trade it on the LME. It was used more for Napoleon III to coat his dinner service to impress his guests when they came around for supper in Paris. So, there's that story of the evolution of the underlying metals, but of course, there's also been the evolution of trading, the move from Sterling contracts to Dollar contracts, the introduction of electronic trading in the early 2000s, and of course our recent discussions around the ring. So, it's fascinating to be part of a world that has undergone so much evolution and which is still progressing today.

It's probably a technical distinction, but I might say 'millinery' rather than 'haberdashery'. Certainly the story that I heard, I've never verified this, but the story I heard is that our first permanent premises were above a hat shop, so that's why I'd say 'millinery', but it's probably quite a technical distinction when it comes to the clothing trades.

I think the really interesting element of our evolution probably came in the late 70s and early 80s, going back to the history, and that was when the aluminium contract really started. You always get this debate in commodities markets about whether things are commodities, and certainly when contracts are launched, I think the LME saw this with aluminium back in the late 70s, and of course we're seeing it now with some of the things we're trying to do, like lithium. There is often this debate that says this particular thing isn't a commodity because customers and users have very specific requirements for particular grades or particular locations where it might be sourced, and so you could have this debate about is it appropriate for this thing to be a commodity. And indeed, if you look at aluminium, going back to the history, that battle wasn't really won until the Soviet Union collapsed in the early 90s and you had all of this aluminium coming out of St Petersburg, and then suddenly people say, okay, this probably is a commodity because there's a lot of it, we can use it all. So, I think it's that inflection point where speciality materials become commoditised and can be traded on a platform, and that's happened at a different rate really for all of our different metals. Say, copper and tin, that battle was won quite early; aluminium in the 90s, and it's a debate that we're having now with the likes of lithium: is this a speciality chemical or is it a commodity which is suitable for commodities trading? So, that's the point at which, to use the term which I think is a great term that you used, when it becomes ubiquitous.

Again, we're extremely privileged. The business that many of us have come into and inherited benefits from that globalisation. Going right back to 1877, the whole premise of the LME was that the metals market was shifting from being an intra-UK market where you could mine your copper and mine your tin in Cornwall and then use it in Birmingham to make things, into a global market. There wasn't enough supply in the UK, and therefore we did need to import copper from Chile and tin from what was then Malaya, and that led to that globalisation. Of course, the famous story of why we have a three-month contract as our reference contract, because it took three months to bring the metal through. Interesting, the Suez Canal existed then, the Panama Canal didn't, so you had those different routes to bring the metal in. So, I think we've always been interwoven into that idea of globalisation, and you then saw that with the membership. At a very early stage, the LME membership was quite broadly distributed, with a lot of German heritage in many of our members, but other countries as well. So, actually, when financial markets, perhaps the more financial markets, began to internationalise, I think the LME had perhaps always been there because of the global nature of the industry that it was serving.

Yeah, absolutely. And it is, as you say, fascinating to trace and track how that's developed and why it's happened. The LME was actually pretty on message in the early 2000s with delivering an electronic trading platform. So the fact that we have the floor, I don't think it's because we were slow to bring that in. And indeed over the course of the 20 years since we've had electronic trading, the LMEselect platform, you've seen what you've seen on many other markets, which is that the share of electronic has increased and the share of open outcry trading has decreased, and that's similar to what we've seen on other markets. The difference on the LME is that we've never gone that final step and seen the floor close. And I think the reason that happened, I'm talking pre-pandemic here, because we can come on to what's happened in the pandemic, is because the floor provides two services: they provide a continuous trading service but they also provide a pricing service. They help us take that snapshot, and because the LME, because of our physical roots, has that rather complex date structure—we're not a monthly futures market with September copper and October copper and November copper—we actually every day calculate the price of copper on 123 different date points from one day forward to 10 years forward. So there has always been, certainly up to the pandemic, this view that it would be very difficult to calculate all of those points on an electronic system because some of them aren't liquid. And as a result, the LME floor has endured, frankly, because nobody, and certainly not myself, wanted to be the one who tried to go electronic and realise that it didn't work and ended up embarrassing ourselves very badly. So, that's why our floor has been so resilient and has stayed much longer than peer venues' floors because of that complex date structure and that view that it was the most appropriate place to do that complex pricing.

So the history, as you can imagine, when COVID was really closing in on the UK, which was that week of the 17th of March 2020, which was that week where it did become, apparently, probably should have known but perhaps nobody wanted to accept, but it did become apparent that the pandemic would be very impactful in the UK, and that was the week it became apparent to us that we really wouldn't be able to continue open outcry trading. So we made provision to move fully electronic as of the 23rd of March, the following Monday of 2020, and that was, I think in many ways, the LME at its best, I suppose. More generally, I think the pandemic has showcased a lot of society at its best and the huge contribution of key workers, etc., and in a smaller but still relevant way, it was the LME at its best. It was everyone working together regardless of their views on the future of ring trading to make sure we could do electronic pricing, which we'd always been worried about. We were fortunate actually back in 2019, we'd done a little trial of electronic pricing in a very limited way, which we in the end we didn't pursue because people wanted to stay with the ring. But fortunately, we'd built a lot of the technology back in 2019, so a combination of the pricing technology which we'd already built and the huge goodwill particularly of the Category 1 members to put liquidity onto the screen and allow us to calculate prices, was extremely valuable. And so, we moved to electronic and it was, I think, much better than anyone suspected. We were very worried and it was actually immensely smooth thanks to the work that everyone put in. But this then caused us a second-order problem, which is that if you fast forward on to January of this year, by January of this year we had nine months of experience, nine months of collective understanding that we could do pricing electronically. And so, the perhaps unintended consequence was that it removed that reason that we'd always said, oh no, we're going to keep the ring forever, because the reason we'd always said we're going to keep the ring forever is we didn't know whether the alternative worked for us. We didn't know whether electronic trading worked. By January of this year, there was a body of data that we felt said, well, this could work pretty well. And at that point, we had as some describe it, a bit of an embarrassment of riches: we had 140 years of floor history, we knew the floor could price extremely well, but we also had nine very good months of electronic pricing history and we knew that could work very well. And that's why in January of this year we put out a discussion paper which for the first time said, okay, Market, we now think that electronic works, so let's have a conversation about should we maybe not go back to the ring after the pandemic because we know that electronic works now. As you can imagine, that created a huge amount of debate and I really appreciate that. We got 192 responses to our discussion paper and I'd much rather have 192 responses, even if there's a lot of different views, than only a small number of responses because nobody cares. So we had 192 responses which broadly split 50/50, particularly when you weighted for trading activity, 50% saying go back to the ring, 50% saying stay on the screen. So what we had to do, as we so often have to do at the LME, is compromise. We are a market that's built on compromise, I think that's a good thing. So the compromise we were able to deliver is that we actually calculate two sets of prices. We do the official prices at lunchtime, they are used in the physical industry, exactly as you say Patrick, from Kabul to Kandahar to Kent, and then we have our evening closing prices which are used by the financial community. So we said let's give each community what it wants: official prices, physical prices, go back to the ring because the physical industry really likes the ring pricing and they really value the service; closing financial prices stay on the screen because most of the people who use those are perhaps more the fund community or the investor community who are used to electronic pricing. So in summary, and sorry for the very long answer, but in summary, we hope we really hope that there's a compromise position now on the table which can be made to work.

We're very fortunate that our core set of products I think have a long way still to grow. If you look at the commodities markets, base metals has always been dwarfed by the energy markets, particularly oil, but we all hope that there will be an energy transition and I think base metals will very much be winners out of that. Be that copper to distribute power to all of our lamp posts so we can charge our electric cars, be that aluminium for lightweighting, be it nickel for the battery in your electric car. So I quite like where we're positioned with our product suite, acknowledging that they are pretty niche compared to what is still a huge energy market. I think going forwards, we have tried to build into adjacencies with varying levels of success. So if you look at metals, we are non-ferrous, non-precious metals, so the obvious adjacencies are ferrous metals and precious metals. Ferrous metals because the steel market is multiples the size of the non-ferrous market, we've made some good progress. Clearly the steel industry doesn't necessarily want its pricing bases disrupted too much, perhaps they're a little bit like aluminium was in the 70s or 80s, but we found some good niches particularly in scrap where there's the ability to launch some pretty successful contracts. On the more disappointing side, we did try to launch the LME Precious venture together with a number of partner banks, which was really looking at taking the London OTC market and offering some centrally cleared and exchange-traded solutions. That has gone less well, which I think is a sign of the success and the strength of the OTC bullion market in London, and so be it. I think it's a great thing that London does. And then probably the third adjacency which has arisen more recently is the specific battery metals, particularly lithium, where we've been doing a lot of work with the industry. Exactly like you say, Patrick, there is a question: is lithium a metal or is it a speciality chemical? It kind of goes back to that point I was discussing earlier about can it be commoditised, can it be traded as a single global reference price, which is generally what works for our market. But we will see, it's a fascinating discussion.

The warehouse network is really the core of who we are because it does allow those contracts to go to delivery, and like most futures exchanges, only a very small proportion of our contracts go to delivery, but that's what keeps our price honest, is that physical convergence and that arbitrage mechanism. So the warehouses, exactly as you say, have grown. Initially they were just in the UK, but today they are in jurisdictions around the world: in the US, across Europe including the UK, including our sort of original port of Liverpool, and then of course across Asia, which is very much where the physical metals market has moved to. They're run by partner warehouse companies whom we license, and those warehouse companies are crucial to maintaining that logistical integrity. But what we always want to make sure is that an LME warrant, so that is the entitlement to 25 tons of aluminium or 25 tons of copper or six tons of nickel, that all of these warrants are the real gold standard for metals in the industry. And actually, there's perhaps a nice little side point to that, which is that just this year, for 140 years ever since we started, those pieces of metal, be they in Port Klang in Malaysia, or Keelung in Taiwan, or Toledo, Ohio, they've been represented by a physical piece of paper which is sat in a vault in London. So we are perhaps one of the last dematerialised markets in the world. So actually one of the big concerns at the start of the pandemic, after we got over the electronic pricing, was that it wouldn't be possible in the event of a very harsh lockdown for the motorcycle couriers to be able to go to the vault, pick up the pieces of paper, these warrants, take them to the members, and then to release the metal. So actually, the whole global metals industry might be gummed up because the motorcycle couriers wouldn't be allowed to drive around London. So what we've built this year and implemented back in March is the world's first dematerialised metals warrant depository. And that doesn't sound particularly exciting if you come from the equities world because you say well everything's dematerialised in the equities world, but if you think about it, equities dematerialisation works because the equities sit under a national law and most countries have their own legal framework that says yes, you can dematerialise equities. There is no such construct for metals that could be sitting in the UAE, could be sitting in the US, could be sitting in Germany. So we've had to be really creative, really innovative in how we've built a dematerialisation legal framework, and that's been a really nice experience working with the members, working with the warehouses to deliver what I think is a great new innovation, which is that we can now dematerialise metals.

I think this is a really interesting question and it goes to one of the big trends that I think we're seeing in commodities markets right now. So exactly as Chris says, the challenge is we produce a global nickel price and what that really means is it's the price of our worst brand in the least desirable place in the world because we're a seller's option market, so a seller of our contract will always deliver the least valuable warrant they can find. Now obviously we have rules to make sure that even the least valuable warrant is still good nickel in an area of net consumption, so it's still valuable. But exactly as Chris says, if you actually want to go and buy nickel in China, you're going to pay LME plus premium because we produce

This single global price, and then it is that reference point, that starting point for the off-exchange bilateral trading for the actual physical sourcing. So what we've seen, perhaps not so much in base metals but in other commodities, is the rise of spot trading platforms. And I think this is a fascinating trend because it's effectively a digital workflow solution for something that's happened since the dawn of time, which is the physical trading of commodities. And I do believe that digitized spot trading platforms where buyers and sellers can come together and not just trade LME metal at the LME price but then say, okay, I want to get more specific, I want to buy this brand of nickel in this port with these chemical characteristics and to pay an upcharge on that and to negotiate that on a spot platform, I think is a really fascinating development. And it's one that we're seeing in a number of other commodities, and certainly the LME has said it's an area that we're looking at in some detail for precisely this reason.

Yeah, thanks Martin again, congrats on the new role, sounds really exciting. I think tokenization is a technology which does have a lot of applicability to commodities markets but perhaps hasn't quite found its stride or found its niche yet. But I absolutely believe that be it for precious or indeed for base commodities and metals, they make a great basis for tokenization. We have very well-established mechanisms for holding them, so you know that you own the underlying. We could use LME warrants to tokenize base metals, or we could, as people already do, use good delivery bars in London vaults to tokenize gold and to then make those available in a way that, as you say, does challenge gold ETFs. And we've never really seen physically-backed base metals ETFs — obviously they're synthetically-backed products. So I do believe that digital asset technology, tokenization, is relevant to our market. The blockchain discussion has obviously had a number of iterations. We've looked at it several times, we've looked at whether we should replace our core systems with distributed ledger solutions. In general there hasn't been a lot of support for that because the way that I think about it is that if you're trading on exchange, everyone wants someone to call up and scream at. So us maintaining a centralized register for our core functions generally is quite popular because then we can't wiggle off the hook — everyone knows that it's our records and that we're the ones to come to if there's a problem. But I think for assets kind of outside the exchange perimeter, perhaps metal in private store that could be tokenized for trading, I'm a big buyer of the digital asset story, and it's certainly an area that we're doing some work on.

Yeah, really interesting question, because obviously we've looked at this, and like all exchange operators, you know, we have an exchange, we have a clearing house, they have a lot of fixed costs associated with them, and so we're always on the lookout for can we add new revenue at low marginal cost, which goes exactly to this question: can we leverage the infrastructure to do more. It is the case that launching new physically delivered contracts, it is tough, and the reason for that is you end up with this sort of wheel of inertia as I describe it — that the pricing is only really relevant if the delivery is working, but delivery is only going to happen if people are trading it, and people are only going to trade it if the pricing is relevant. So it is tough to simply go out and say, hey, we're going to launch a new physically settled contract, and that's why the vast majority of new contract launches, including on the LME now, are as financially settled contracts. So we go to a price reporting agency who is compiling quotes based on telephone discussions, etc., they publish a price for say lithium as we were talking about earlier, and we then financially settle the contract to that price. Now obviously we like those, they're easy to do, they work quite well, but I really sympathize with the question. I'd love to see more physically traded, physically delivered contracts because I do think that gives the best exchange pricing. Maybe the way to break that circle is through the spot trading, because if we see commodities start to trade on spot platforms and then a particular brand or a particular quality becomes the dominant one, then you could say, okay, that now feels like the right spec to use for physical delivery of a futures contract, and you could effectively suck the trading that's happening on that spot platform into being the delivery leg of your futures contract. I'm not sure anyone's done that yet, although arguably that's where most physically settled contracts came from many years ago. But maybe that's the way to break that circle of inertia as I describe it.

Absolutely. Well, there's certainly a lot of innovation in the space because as I'm sure you know, we moved out of Leadenhall Street about six years ago now, and the owners of Leadenhall Street, they decided that they wanted to maintain the ring as an event space. And I think most recently before the pandemic — it might have started again — it's been doing immersive theater. So there was an immersive War of the Worlds experience based on the Jeff Wayne musical. Actually I really liked that and I wanted to go and see it but I didn't get in before the pandemic. So maybe we're not going to go quite as far as offering immersive theater in the new ring, although if anyone has any ideas for that then feel free. Maybe there's some amateur dramatists. But I do think that the ring can do more, and now having reached this point where I think we have a stable compromise, as I say, with those official prices in the ring, I fully realize that the ring dealers don't have as much business to execute on the ring as they used to. Obviously we've tried to help that through fee discounts, etc., but the question is will that be enough given that we now want this compromise to work, we want the ring to have a solid future. Other commodities, other ideas — talked about options in the past, you know, maybe those are all things that we could look at, and we're very open to those discussions.

Yeah, and the LME Clear team who built that platform, as you said, that was in train even before the HKEX acquisition. I think really had an opportunity to build that clearing house from the ground up as any MIFID II-compliant clearing house but also as a real-time clearing house — so assessing risk in real time, running the calculations, calling margins. So it was a great opportunity as a relatively new entrant to build a best-in-class clearing house, and we're very proud of the way that it runs today. You know, there's only three clearing houses left in London, which I think speaks to the challenges of their scale and the regulation, obviously the issues we've had around Brexit preparedness. But we are very proud to have our own clearing capability. I think it is important if you want to be a real player in the capital markets game, because it means we can bring products to market more quickly and it means that we can work very closely on things like optimal margin levels, etc.

Yeah, I certainly think it's meant we can be more responsive, more adaptive. So a couple of examples of that. The first is that we can build new functionality that's quite specific for the metals markets. An example of that — it's one that isn't used as much as I would like it to be, but I think is actually a really clever solution — is the use of warrants as collateral. Because our members are generally sitting on a lot of metal represented by these metal warrants, and depending on which way your contract is, they're either a perfect hedge or a hedge with a bit of wrong-way risk, but that can be managed. They are a very good source of collateral that we can use to mobilize that liquidity and hopefully help people to trade more. And that's something that you can only really do when you have that in-house clearing capability and that very strong linkage within the group. So it certainly has helped us to drive forward the strategy probably in a quicker way.

Yeah, so before being at the LME I was an M&A adviser in banking. You know, so you'd work on all of these deals and then you'd walk away and work on the next deal, leaving behind you all of this scorched earth that transactions always cause. And I had the privilege of working for HKEX on the acquisition, and Charles Li, who was then our group CEO, he said, well, you know, at some point you're going to have to have the guts to actually take part and see what happens with one of these deals that you advise on. So I thought, yeah, maybe this is the opportunity. Charles is a great boss and there's a great team at HKEX, so it felt like the right time to make the move from advisory and move in-house. But it was certainly not what I would have planned for my career. Certainly knew nothing about metals, not a huge amount about commodities — most of my work had been in equities trading — but it's been a great learning journey over the last nine years.

Yeah, and I think these are quite difficult, almost philosophical questions for an exchange because we have to understand what our perimeter should be. So to give you an example with that ethical sourcing point — so we have a cobalt contract, it's a physically settled cobalt contract, and ironically it's actually a tiny contract, it trades very small volumes, but because we have a physically settled contract we maintain the brand lists, the good delivery brands of metal that can go into the warehouse, just as we do on aluminium and copper and the others. And it was back in 2017, I think, that there was an FT article which said that some of the brands that the LME had licensed or had recognized were really not doing the right thing around ethical supply chains, around child labor, around conflict finance. And clearly this story had quite a big impact on us because if it had just been, you know, such-and-such smelter that perhaps people in London hadn't heard of, it wouldn't have been a really big story. But the fact that we had recognized those brands brought it home, I think, for London and particularly for us. And so we were very quickly catapulted into an area that firstly I knew nothing about and secondly I didn't even know whether it was our business getting involved in, because do we really have the standing, the position as the LME to be this ethical police going around saying what's good and what's bad. And we did a lot of work on this and had actually some really good discussions with civil society, we have non-governmental organizations who obviously have done huge amounts of work on this topic. And in the end we did decide that we couldn't do nothing. And there's kind of a high-principled reason for that and a more commercial reason. The high-principled reason is obviously we want to do whatever we can to avoid abuses and help out, you know, and try to remove child labor, etc. But there's also a commercial reason which is that if these issues are affecting metal on the LME, then very quickly LME metal will become seen as tainted and the whole price that we derive from that metal will be seen as tainted. And if we produce a price that's tainted, we have nothing — we are the quality of our pricing. So we did decide that we were going to embed the OECD principles for responsible mineral sourcing into our brand listing requirements. So for 140 years we've said you can list your copper on the LME as good delivery as long as it meets these metallurgical tests, and frankly we didn't care where it came from. And for the first time, starting this year, we're introducing requirements that say it's not good enough to just be metallurgically sound, you have to be ethically sound, and we have very clear rules on that that come from the OECD. So we haven't sat down and imposed our own ethical standards on them, we've taken the OECD position, but importantly we have implemented them. We've turned them into exchange rules, because as your viewers will know, exchanges live and die by their rulebooks, right? They have to be very binary in terms of what's good and what's not, otherwise you end up in court. We've had that at the LME before, I've had that at the LME before. So you have to have really clear rules, not more than guidance, saying here are the standards you must meet, and if so you can be an LME-listed brand, if not, sorry, you can't be. And I hope that that's the right thing to do. It's been a long journey, a lot of work. It's been scary at times because we've been worried that brands would delist, but as you say, Patrick, the world's moving on, and now I think pretty much everyone is aligned on the fact this is the right way to move.

Great question. So I would say that the issues on child labor, on conflict financing, they are clear cut. There is basically a global consensus that nobody wants to see those in supply chains, and that's why we were able to say, yeah, this is a bright-line issue. If you can't show that you meet these requirements, sorry, you can't be part of the party. But you make exactly the right point, because you very quickly get into issues that are more spectrum issues and are more subjective. So let's take probably the most obvious one right now, which is carbon content. So obviously everybody wants to know that the metals they use have a low carbon content, but there is no agreement in the market as to a threshold. You know, saying if I take aluminium, you could say, oh, any aluminium that has produced more than six tons of carbon dioxide equivalent per ton of aluminium smelted is high carbon and it must be removed. But that's simply not going to work — because there's no science around that number, because nobody agrees on it, and because if we did that there wouldn't be enough aluminium in the world to use for lightweighting and recyclable cans and all these pro-environmental topics, so we'd actually hurt the environment. So for topics like that which don't lend themselves to a yes-or-no, good-or-bad distinction, I believe the solution is much more around disclosure. So we're launching — actually launched earlier this month — a system called LMEpassport which for the first time allows data about metals to be tracked on a per-ingot or per-tonne level, and so we can now facilitate both metallurgical and sustainability data being attached to pieces of metal in our warehouse. And I think that's the right way to do it, because it's then not the LME saying, oh, it's six tons of carbon dioxide or it's eight tons of carbon equivalent — it's about the LME saying, we'll help you understand the impact of your purchasing decisions and you should then make the right decision based on what your downstream consumers are going to say. I think that's a very nice capitalistic, markets-led solution to a problem that's going to be a big issue for markets.

Yeah, so I think it's going to be very much a democratization of capital markets. I think actually what we've seen during the pandemic, as people wanted to have things to do and got a lot more involved in capital markets — whether that was trading meme stocks or in some cases we saw trading commodities — I do think that democratization, that idea that individuals can participate in capital markets, is a really powerful force. And it's one that we feel quite acutely at the LME because our copper contract, particularly with where copper has gone recently in terms of price, our copper contract is a quarter of a million dollars notional, right? That's $20,000 of initial margin to trade one contract. That doesn't feel particularly democratic or accessible. And it's why we're pushing quite hard on our mini contracts that we actually list on our parent exchange in Hong Kong, and it's been really nice to see them do some good volumes this month. So I think that idea of people getting closer to capital markets, be that through mini contracts, be it through micro contracts, be it through tokenization, I think is a really powerful force. That's obviously from a self-interested perspective, it's going to drive more volumes, we've seen that. But I also think it will make people feel closer to the markets, it'll make them feel that the markets are there to serve them. And particularly if we can add to that the issues that we know people care about around sustainability, if we can give them the transparency, I think that could be a very good social contract as it were in terms of how markets operate.