UPDATE 2-LME tries Chinese medicine to cut metals warehouse queues
* Proposal links load-in, load-out rates for warehouses
* First response from metals market is positive
(Updates with comment)
LONDON, July 1 (Reuters) - The London Metal Exchange (LME) proposed a major overhaul of its metals storage system on Monday that, if implemented, will help soothe irate industrial clients and curb profits for banks and trade houses that own warehouses.
Several companies with warehouses registered by the LME, including Glencore, Trafigura, Goldman Sachs and JPMorgan, have found a lucrative business in building up big stocks, charging rent for storage and only delivering it out at a limited rate.
Its industrial clients blame the exchange for letting long queues build up for material they have bought via the LME and want to withdraw from warehouses in the global network it oversees. Users can wait for up to a year to get their material.
The proposal, which will link load-in and load-out rates for warehouses with queues with a waiting time of more than 100 calendar days for material, is open to the metals market for a three month consultation period.
"We appreciate the market's concerns on the current length of warehouse queues," said Diarmuid O'Hegarty, LME chief operating officer.
"This new proposal could help to alleviate the issue and we would like to hear whether market users agree."
Initial responses from the market were positive. One industry insider, a critic of the current system, suggested it could even be the silver bullet for the problem that has vexed the LME and its new owner, Hong Kong Exchanges and Clearing .
"This looks like somebody really thought about it," the industry insider said. "And thought not only about the issue itself, but about the secondary consequences."
LME rules currently stipulate a minimum delivery rate for metals stored in the warehouses it monitors. Warehouses do not have to ship out any more than that amount, which is 3,000 tonnes per day for a warehouse company holding more than 900,000 tonnes of metal in one location.
This means that in Detroit, for instance, where aluminium stocks are around 1.5 million tonnes, anyone wishing to withdraw supplies face a wait of around a year and pay rent while they do so.
While aluminium supplies are plentiful on paper, surcharge, or 'premiums' paid over the LME cash price to cover physical delivery costs, are at a record of around 12 cents per lb in the U.S. Midwest.
"I think HKEx appears to have been motivated partly by concerns that the LME prices seem to be breaking, if not broken in some of the metals markets," Macquarie analyst Duncan Hobbs said.
"I think it is too soon to say if this will fix the problem, and it depends on what changes they implement. But I think what we can say with a fairly high degree of confidence is that there will be change both in what they do and in terms of the market response."
In a blog on Monday, HKEX Chief Executive Charles Li wrote that he viewed a persistently high premium as an unhealthy physical condition, such as swelling, "that is not life threatening but is highly irritating and has the potential to cause long-term harm".
"This can't be solved with either a bazooka or a surgical operation. Instead, a modest approach, such as "Chinese medicine", might be the cure," Li said. "That's what this consultation is all about."
Li said last year that the issue of warehouses backlogs nearly derailed the LME deal, and he promised to aim a bazooka at the problem.
A final decision on whether to implement the changes is expected to be made at a scheduled LME board meeting in October. If the proposal is adopted, the new rules would come into force on April 1 next year.
Under the new proposal, all of the metal loaded into a warehouse over a three-month period will be measured. If there is a queue of more than 100 calendar days the warehouse would be expected to deliver out extra metal based on a formula.
For example, a warehouse currently required to deliver out a daily tonnage of 3,000 tonnes would, under the proposal, need to load out at least 1,500 tonnes per day more than it loads in.
Also, if the current load-in rate of an affected warehouse exceeds the minimum load-out rate, then the warehouse would be required to deliver out tonnage equal to that excess.
Outgoing LME Chief Executive Martin Abbott has always maintained that low interest rates, which make financing deals possible, are to blame and that raising minimum load-out rates would not help.
When the LME raised load-out rates last year, warehousing companies promptly raised rents to compensate for the higher outflow of metal. Industry sources have warned this could happen again.
"People also find ways around rules," said a Europe-based physical trader.
(Additional reporting by Veronica Brown; and Maytaal Angel, editing by William Hardy)