CME turns up the heat on LME with new copper contract: Andy Home

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LONDON (Reuters) – CME Group’s new copper premium contract, launched this week, is another sign of increased competition in the world of industrial metals trading.

The London Metal Exchange (LME) may still set the reference prices used by much of the world’s physical trade, but CME has been stepping up its challenge with a number of new contracts over the last couple of years.

This latest product is cash settled against Metal Bulletin’s assessment of the physical premium for Grade A copper delivered to Shanghai.

It mirrors the CME’s drive into the physical aluminum premium space and seeks to build on a recent surge in trading activity in its core copper futures contract.

It also exploits the failure by the LME and its Hong Kong owner, Hong Kong Exchanges and Clearing (HKEx), to open up the mainland Chinese market.

But China may be about to open itself up without any help from anyone else.

Indeed, if the Shanghai Futures Exchange (ShFE) succeeds with its own commodities trading experiment, the battle for global metals dominance may have only just begun.

Graphic on CME aluminum premium contracts: tmsnrt.rs/2zXjZt5

GETTING PHYSICAL

CME will be hoping its new copper contract fares as well as similar products in the aluminum market.

Its physically-settled aluminum contract has struggled to gain traction, as have its lead and zinc contracts.

But the premium contracts, indexed against both Metal Bulletin and S&P Platts regional premium assessments, have done a lot better, even though the premiums overlay LME not CME contracts.

Volumes across the four CME aluminum premium contracts rose by almost 50 percent year-on-year in the first 10 months of 2017, while open interest was up by 36 percent.

The first, the US Midwest premium contract, was launched in 2013, a time of industry anguish about the disconnect between premium and underlying LME contract, a fragmentation of price that was widely attributed to the LME’s then problems with load-out queues in its warehouse system.

CME’s ability to exploit this discontent was facilitated by the LME’s own slow response and its subsequent launch of overly complex physically-deliverable premium contracts which have failed to trade.

Timing is everything in the new contracts game and the timing may be right for a China premium copper contract.

For several years spot Chinese premiums have traded at a discount to the annual terms for producer shipments.

This year’s producer premium for China was set at $72 per tonne, but Metal Bulletin’s assessment of the spot market averaged just $58.00 in the first 10 months.

This persistent spot premium discount has led to an increasing shift in pricing towards shorter-dated or even fully floating premiums, creating latent demand for a way of hedging that exposure.

Graphic on CME Copper Open Interest and fund positioning: tmsnrt.rs/2AmRdTg

NEW FRIENDS IN EASTERN PLACES?

But CME has something else going for it with this new contract.

Long overshadowed by its London rival in the copper trading world, it has seen a remarkable change of fortunes over the last two years.

CME copper futures volumes increased by 16 percent in 2015, 27 percent in 2016 and are already up another 31 percent so far this year.

Open interest has been breaking fresh records on a regular basis over the last year, while options open interest at the end of October was at an all-time high of 12,218 contracts.

Compare and contrast with the LME, where copper volumes have been falling over the last two years.

It’s not that CME is actively taking existing market share from the LME, but rather that it is the venue of choice for a new generation of market participants.

The step-change in trading activity dates from the fourth quarter of 2016 and coincides with a similar scale-up in fund positioning.

It’s widely accepted this reflects the advent to the CME contract of Asian money, particularly Chinese money. Speculators are choosing CME over LME because it is both cheaper to use and easier to understand with its vanilla futures structure.

The new physical premium contract is potentially another way of cementing this new relationship.

GOING OUT OR COMING IN?

Grabbing more of China’s metals trade was supposed to be one of the goals of HKEx, when it bought the LME in 2012.

But after failing to persuade Chinese regulators to rescind a ban on overseas exchanges operating warehouses on the mainland, HKEx has been left to try and build its own domestic market with which to connect. [nL5N1LS424]

That ban was put in place to protect the ShFE, which dominates the domestic market and which, thanks to its often huge liquidity, is increasingly starting to influence LME pricing.

As with other domestic Chinese commodity exchanges, the ShFE has historically existed in its own mainland space, ring-fenced from international trading by currency, tax and regulatory barriers.

That may be about to change with Shanghai’s proposed crude oil contract, due to launch before the end of this year.

ShFE’s new subsidiary, Shanghai International Energy Exchange, is open to foreign participation in a way that hasn’t been the case for any previous Chinese commodity market.

If the experiment works, expect a similar opening-up of existing Shanghai metals contracts, with copper a prime early candidate.

The Chinese authorities have decided that the domestic exchanges are nearing the point of maturity where they can compete with overseas markets such as the LME and CME.

“We should seize the historic opportunity … to escalate the opening up of the futures market to the outside world and improve the global competitiveness and influence of China’s futures market,” Fang Xinghai, vice chairman of Chinese market regulator CSRC, told an assembly of ShFE members in September.

The “Belt and Road” initiative should be leveraged to introduce foreign investors to Chinese contracts such as oil, iron ore and natural rubber, he said.

Moreover, “futures exchanges are encouraged to set up overseas delivery warehouses and representative offices.”

After stopping the LME coming in, the time appears to be approaching for the ShFE to step out.

The new CME copper contract is but a small move in what is shaping up to be a much bigger three-way competition for global pricing.

Editing by Greg Mahlich