NEW YORK/LONDON (Reuters) - CME Group Inc (CME.O) has canvassed traders in recent weeks about the viability of an aluminum contract to rival that of the London Metal Exchange, which has dominated the $80 billion market for decades, industry sources said.
The talks are at an early stage, according to two traders who said the CME had approached their companies. They said the Chicago-based exchange is seeking to capitalize on frustration with the 135-year-old LME’s handling of its warehousing policy and to break London’s grip on the 40-million-tonne market.
After losing in the final stages of the year-long takeover battle for the LME in May, the CME has little choice but to challenge its rival head-on if it wants to expand its share of the lucrative global metals market, dealers say.
In addition to motive, the CME also has opportunity: aluminum users that make the sheet metal for drinks cans and cars are still seething over massive queues and record premiums tied to the LME’s global warehousing system.
“We had the CME coming through our office saying ‘We hear people are angry.’ They want to do another contract. They kept bringing up the warehouses,” said one of the traders, who spoke on condition of anonymity because he is not authorized to speak to the press.
That sentiment could help a new contract succeed where others failed. The New York Mercantile Exchange (NYMEX), now owned by CME, struggled for 10 years to gain traction with a North American aluminum contract before being delisted in 2009. It was unable to lure established users away from London.
A CME spokesman declined to comment on any such plans. He said the Chicago exchange was focusing on its aluminum swap contract, which launched in April but has yet to trade.
The LME declined to comment.
The LME, considered the crown jewel in the global metals market, has dominance in six base metals futures markets. In contrast, copper is the CME’s only base metals product, and an aggressive move into aluminum futures would have been considered unthinkable just a year ago.
But with the new owners Hong Kong Exchanges and Clearing Ltd (0388.HK) expected to hike transaction fees at what was one of the world’s last member-owned exchanges, the LME is heading into a vulnerable period, traders said.
“(Given) the trouble the LME is having with its own (aluminum) contract, it has a better chance of succeeding than ever before,” said a senior executive at a Category II member.
“I don’t think it’s just about anger, it’s about the world moving forward,” he said. “The LME has had a monopoly, and if you change your business model and charge fees then you lose one of your competitive edges.”
IntercontinentalExchange Inc (ICE.N), which has no base metals presence but was runner-up in the battle for the LME, may also step into the fray, traders said. ICE declined to comment.
Details on the CME plans are scant, but the Chicago exchange’s competing contract would be deliverable against physical metal, similar to the LME, the two traders said.
That means the CME would need to build a workable warehousing policy different from the LME’s to ensure metal is not stuck in queues, traders said. It is unclear whether it would be a global or North American contract.
Traders warn it is no simple task. The saga over the LME’s warehousing policy has gripped the market for four years. The exchange has struggled to modify its complex system and satisfy traders, consumers and the warehousing companies.
While LME prices languish around two-year lows, North American aluminum buyers are paying record premiums topping 11 cents per lb for physical delivery on top of the base price.
The cause is not a supply shortage, critics say, but the fact that warehouses owned by JPMorgan (JPM.N) and Goldman Sachs (GS.N) offer financial incentives and financing deals to store metal in their facilities -- forcing end-users to bid up prices to secure the metal for their own needs.
Almost 5 million metric tons (5.51 million tons) of aluminum has been pulled into LME-bonded warehouses over the past five years, much of it locked in for years at a time.
The other unresolved issue is wait times to take delivery. An owner of aluminum in a Detroit warehouse may have to wait a year before receiving their metal due to enormous queues.
The LME has raised the minimum load-out rate for some locations to placate angry users, but is now gearing up for another review as the bottlenecks show no signs of easing.
Beyond the vexing storage logistics, the CME must also overcome the inherent inertia of a traditional industry often resistant to change. After launching in 1978, the LME’s contract took seven years to win over producers.
“It’s a tall order to get the market to shift. For a contract to be a success, you need producers, traders, consumers and speculators,” said the first merchant.
The CME has recently taken market share from the LME’s benchmark copper contract, with trading volume in the COMEX contract, launched in 1988, rising more than 50 percent from a year ago. The LME has gained just 16 percent.
But New York volume is still just one-fifth that of London.
And signs of rivals moving onto its cherished turf may push the LME’s new owners to find a long-term solution to the issue.
“It will be interesting to see if this aids the LME’s thinking in resolving the issue,” said Standard Bank analyst Leon Westgate. “If somebody else is looking at the issue, it certainly gives them something to focus their attention on.”
Additional reporting by Melanie Burton in Singapore; Editing by Dale Hudson and Jim Marshall