Goldman cautions on London Metal Exchange rule proposals


LONDON, Nov 4 (Reuters) - The London Metal Exchange'sproposals to cut queues to get metal out of the warehouses couldincrease price volatility and reduce transparency as more metalmoves off the exchange, Goldman Sachs said in a researchnote.

The LME, the world's largest metals marketplace, has comeunder regulatory and legal scrutiny over its metal storagepractices, with complaints about months-long queues to withdrawphysical metal from its warehouses.

Clients of the warehouses say the system inflates the cost,or premium, to secure metal. This is particularly so foraluminium, which is used in packaging and transport, even thoughthe market is in global oversupply.

In July, the LME proposed new rules to overhaul thedelivery system from next April that would force warehouses torelease more stocks once the wait-time breaches 100 days.

The exchange, acquired by Hong Kong Exchanges and Clearing last year, said last month it had made a decision onits proposal, and would reveal details at a later date.

Goldman, which owns metals warehousing firm Metro but hasChinese Walls between its research, banking divisions andwarehousing operations, said premium volatility had indeedincreased the cost of using the LME as a hedge against physicalprices.

"Clearly, should these costs increase, the demand for theLME as a hedging tool against physical price risk may decline,"Goldman said.

"But going too far in the other direction in managing thisbasis (premium) risk may also impact the economic role of theexchange market - reducing transparency, liquidity and impactingthe ability of the LME to create a buyer of first resort andseller of last restort."

To support the mechanism of physical delivery of its futurescontracts the LME approves and licenses a network of around 700warehouses across 36 locations around the world.

"Increasing the load-out rate potentially lowerstransparency and increased LME rents and delivery-out charges aswarehouses attempt to recoup the costs of investing inadditional capacity to load out," Goldman Sachs said.

And limiting the load-in rate reduces the LME's ability tocreate a market of last resort in times of surplus, it said.

"We find that 'managing' the queue by the LME could havesignificant direct costs in the proper functioning of theexchange which can increase price volatility and indirect socialcosts by reducing transparency as more metal moves offexchange," it said.

LME warehouses hold 5.4 million tonnes of aluminium, but itis concentrated in only two locations: Detroit, where Goldman'sMetro dominates, and Vlissingen in the Netherlands,Glencore-Xstrata's Pacorini stronghold.

Metal buyers' complaints have resulted in U.S.-basedlawsuits by consumers, distributors and others allegingaluminium price-fixing and anti-competitive behaviour byinvestment banks, large trading houses and the LME.

Goldman, a defendant in some of the lawsuits, has dismissedthe lawsuits against them as without merit.

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