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UPDATE 1-LME faulted for warehouse review, now faces legal bind

(Adds lawyer's comment in paragraphs 16, 20)

LONDON/NEW YORK, March 28 (Reuters) - A court ruling has faulted the London Metal Exchange for failing to consult users on alternative ways to reduce vexing logjams in its warehousing network, the backbone of the world's biggest market for copper and aluminium.

The remedy: Reconsider an option the LME has long believed is illegal.

The High Court in London ruled in favour of top aluminium producer Rusal on Thursday, saying the rule-making process was "unfair and unlawful" because it had presented only one viable option: reduce queues by limiting how much can be brought in and out each day, a measure that has now been put on hold days before it was due to come into effect.

The 22-page decision held several startling revelations about the LME's secretive three-month consultation process, including the fact that a landmark 2011 study into how to resolve the lengthy waiting times that the LME had declined to make public offered five different suggestions.

In particular, Justice Stephen Phillips wrote in his ruling that the exchange should have publicly considered a measure the LME and many experts had said repeatedly would be deemed anti-competitive: banning or capping the rent that warehouse operators could charge on any metal that got stuck in the queue.

The decision also said the LME had consulted its warehousing committee last September about banning rents, which is an unpopular option among the committee members because many of them own warehouses. The LME had started its own study of the issue but did not disclose this information to the market.

The fact that the LME was reviewing competition law even while moving forward with the "load in, load out" measures is "tantamount to an admission that it had failed to make sufficient enquiry and had failed to consider relevant matters prior to commencing the consultation", Phillips said.

The decision, which the LME could appeal, dealt a deep blow to the LME and its new owner, Hong Kong Exchanges and Clearing , which had stood up to big banks and metal producers in order to push forward new rules that would put to rest years of complaint over long waits to pull metal out of storage.

Chief Executive Charles Li now faces a conundrum: appeal the ruling or put forward revised proposals that may include options the exchange does not believe would withstand legal scrutiny.

"Year in and year out we've been told that the LME cannot cap rents because of legal issues," a metals industry executive said.

THE MOST 'RATIONAL' OPTION

The ruling threatens to unravel the exchange's years-long effort to restore confidence among end-users in its aluminium contract, its biggest by turnover and liquidity but dogged recently by queues as long as 18 months.

Due to lucrative financing arrangements, big banks and traders that own warehouses, including Goldman Sachs and Glencore, have profited from long queues that have developed as buyers continue to pay rent while waiting to be loaded out in turn. Metal users such as Coca-Cola Co have complained about inflated prices.

Threatened with lawsuits by consumers and wary of regulators, the LME thought it had finally found a solution among its divided stakeholders.

Yet during the consultation period, the LME was flooded by calls to ban or cap rents. At least 10 of 33 written responses to the LME's July 2013 proposal recommended that option, according to the ruling.

The exchange did not include the option in its consultation despite saying in a November notice that the concept "appeared to be one of the most rational and deliverable".

"Given the law at the moment, it should be easy to do a lawful consultation, but it's surprising how often public bodies mess them up when it really shouldn't be that hard," Gwendolen Morgan, an associate at London law firm Bindmans LLP, said.

Philip Crowson, a former Rio Tinto economist, was asked by the LME to commission and oversee an impartial 2007 study into warehouse charges. He urged the exchange to be vigilant over all warehouse rents and charges, but said the LME did try to challenge the constraints of British and EU competition law.

"They tried vigorously, and all the legal advice both from Brussels and from London was that they weren't able to fix maximum charges or warehouse ownership," Crowson said late last year. "They certainly tried."

Morgan suggested there are sometimes other options.

"They (public bodies) sometimes claim something is not legally possible, but sometimes the position is more nuanced or there is some creative way around the problem if they want to achieve a certain aim," she said.

RALLYING BACK

The LME said on Thursday that other reforms would go ahead, including a logistical review, a new physical markets committee and new position data. It had warned last month of "serious concerns" over its ability to maintain an orderly base metal market if forced to repeat the consultation.

Some industry sources say the setback for the exchange is temporary. If it decided against an appeal, the LME could launch a repeat consultation that would include both options - the load in, load out rule and banning rent in queues, industry sources said.

Any delay from taking that route would not be as long as the initial consultation, the sources said.

"This is a temporary setback for the LME. They didn't do their homework, but even so it doesn't change anything," an industry source said. "Make no mistake, the rules will still be implemented."

(Additional reporting by Veronica Brown; Editing by Jonathan Leff, Lisa Shumaker and Dale Hudson)