‘India must be a metal price setter globally’

With growing volatility in commodity and currency markets, providing a viable derivative platform for hedging commodity price risk has become imperative in India. As the larger stock exchanges, the BSE and the NSE, begin commodity derivative trading, there is greater focus on making these platforms relevant for companies and farmers to hedge risk. Convergence of prices in physical market with commodity derivatives and zeroing-in on the right price to use as underlying for derivative contracts become important in this context. Matthew Chamberlain, CEO of the London Metal Exchange and member of the Management Committee of HKEX Group, discusses these issues in an exclusive interview with BusinessLine . Excerpts:

In order to ensure convergence, you have to ensure ease of transaction for those who deal in the contracts — the sellers should easily be able to make the delivery and the buyers should be able to take the physical delivery. So, we spend a lot of time in LME to ensure that warehouses are available in key global areas of metal flow and metal consumption. Obviously we would like to set up warehouses in India as it is one of the key countries that is missing from our network; given the importance of Indian metal industry, we would like to see if we can resolve that.

The second part is about having strict rules that create a delivery framework. We have a brand list that includes a number of high quality Indian producers whose metals can be delivered at LME. And thirdly, it is about always keeping on the top of everything. As you may know, in the financial crisis, a lot of aluminium went in to the LME warehouses, but they were not moving out fast enough. Clearly, when that happens, it makes it more difficult for people to use the network and the convergence does not take place as it should. We had to take action to deal with that.

We went through a big financial review last year and this was one of the issues that we grappled with. What we said was that our primary focus is on the physical markets. What that means is that if the physical market wants us to do one thing and the financial market another, we will do what the physical market wants. A good example is our daily contracts structure. Financial markets typically want monthly contracts, because they are easier to trade. But we went with the daily contracts since that is how physical market trading takes place. We may get lesser business from financial traders due to this, but we are okay with that.

In broad terms, our trading splits into a third from physical hedgers, a third of investments – hedge funds, mutual funds etc. and a third are algorithmic traders.

The daily settlement is a historical feature. Because we always produced a daily price, physical settlement prices are based on the LME prices. Since physical contracts need daily LME settlement price, it is kind of locked in the system, but it does increase the complexity, both for us and people who trade.

It’s a really good point because we clearly are in a political environment where there is bit of de-globalisation, regionalisation, whatever we may want to call it. The fact is metals are still a global market. Look at US, even with the tariffs, metals keep flowing in to the US because it is a large consumer. What I take from that is that base metals are, in my view, a global market.

I absolutely agree that India should not be a price-taker. Nobody should be a price-taker. India should play a full role in setting global prices; I believe that at the trading layer, that is already happening. When people trade on the MCX, the algorithmic traders pick price signals from MCX platform to influences the LME prices. They look at the MCX book to trade on the LME book. So Indian prices are already influencing global prices, as they should. People are investing in very fast connections between London and Mumbai to bring prices together.

I would like to take this further and see Indian physical signals influence global prices. And the best way to do that would be to put up warehouses in India so that Indian supply and demand would influence global prices, just as US, German or Malaysian warehouse stocks do.

We will have to work with our local partners and with regulators to see the structure. LME warehouses are typically in an offshore zone, because we like to keep them away from the taxes in the country. The key thing is, is this what Indian industry wants? Clearly there is market engagement to do and some legal and regulatory engagement to do. But I would love to do that because it would make India play its full part in global markets.

If you take Hindalco’s metal, it is stored in our warehouses across the globe. So it is not just Indian metal that would be stored in Indian warehouses.

If you look at a typical metal market, 90 per cent of metal production is sold through long-term contracts with their customers. It is the marginal 10 per cent production that goes to merchants, gets traded in the spot market or on the LME, that you would expect to be see in warehouses.

It’s much less than one per cent. A delivery contract need not always be delivered. It just means that it can be delivered. THis helps keep derivative prices in line with the physical markets.

Clearly Brexit changes our relationship with the EU. But we are lucky because there isn’t really a metals exchange in Europe. So there isn’t any agenda to move metal trading to continental Europe. Rather our European customers are putting pressure to be able to continue accessing LME trading.

We have six members based in continental Europe who are working closely with regulators and politicians in Europe. Last week Europe put out a statement that EU traders will continue accessing UK derivative venues for both trading and clearing. This gives us confidence that even if there is a bad Brexit, trading will not be disrupted much.