Sole survivors: LME pit rules

June 23, 2014 05:05 AM

Today’s decision to continue pit trading at the London Metal Exchange not only preserves the vanishing tradition of face-to-face bidding, it helps the exchange remain credible in the wake of scandals in the setting of other international benchmark prices -- currencies and the interest rate known as Libor.

When Hong Kong Exchanges & Clearing Ltd. bought the LME for $2.2 billion in 2012, it pledged to stick with open outcry trading until at least January 2015. For now and into the indefinite future, traders in suits, ties and dark shoes, seated on red leather sofas arranged in a six-meter (20-foot) diameter circle called the ring, will continue to determine prices on six main industrial metals that firm around the world use to settle their books every work day, according to today’s announcement.

The LME is investing £1 million ($1.7 million) this year in technology to help integrate the floor and electronic pricing. The ring will remain open beyond 2015 and the bourse will work with users to keep pace with market changes and generate more volume. The decision comes after a six-month review with more than 25 stakeholders including 11 ring trading members from JPMorgan Chase & Co. to Societe Generale SA.

“The ring will remain open as long as necessary and the market will decide when and if it will change,” Garry Jones, chief executive officer of the LME, said in a telephone interview today. “We continue to invest in everything about it.”

Meets Principles

The LME concluded through an internal audit this year that the ring meets principles for financial benchmarks set by the International Organization of Securities Commissions, the bourse said. It has introduced more than 20 new rules since 2010 to ensure the efficiency of the price-discovery process.

“The high concentration of liquidity in the ring makes it difficult to manipulate the ring-generated settlement,” said Christopher Gilbert, a professor at the University of Trento in Italy who has followed the LME for four decades.

To keep settlements difficult to manipulate, the LME records ring sessions with microphones and video cameras to capture traders barking at one another to buy and sell aluminum, copper and zinc, among other metals. The recordings capture the back and forth of traders who strive to get the better of one another during working hours and then raise a pint together at the bar Dion next door before commuting home.


“To be a good trader you have to be thick-skinned, able to make quick decisions under pressure,” said Andrew Patterson, head of EMEA metals trading at Paris-based Newedge Group SA, another ring trading member. “And if you want to be a ring trader, you have to be all those qualities as well as forthright, direct and loud. It’s a very tough environment. Once the bell goes, however, everyone is relaxed and will socialize.”

Metal traders have mostly avoided the scandals that have shadowed their trading colleagues in currencies and Libor. More than 30 foreign-exchange traders have been fired, suspended or put on leave as regulators and prosecutors on three continents investigate the setting of benchmark rates.

At least nine financial firms, including Deutsche Bank AG and Barclays Plc, have been fined a total of more than $6 billion for manipulating the London interbank offered rate, or Libor, which helps determine the interest paid on $300 trillion of assets around the world.


“In this current environment of transparency the value of having the open outcry mechanism is not something they would ignore and it’s not something they would turn their back on very lightly,” said Michael Overlander, CEO of ring member Sucden Financial Ltd. The ring is a good place to experiment with the ways it can bring more value to the exchange, he said.

In an age of stocks selling in milliseconds, the LME is Europe’s only open-outcry trading venue, according to the exchange. The 137-year-old bourse, where $14.6 trillion worth of contracts changed hands last year, maintains the practice even as London bourses from the International Petroleum Exchange, taken over by IntercontinentalExchange Inc., and the London International Financial Futures and Options Exchange, acquired first by Euronext NV and then ICE, closed their trading pits in the past two decades.

“Other exchanges have moved away from open outcry with the idea of efficiency in mind,” said Caitlin Zaloom, professor of social and cultural analysis at New York University and author of “Out of the Pits: Traders and Technology From Chicago to London.” “The idea is that computer-based trading can be done more quickly with smaller spreads and fewer middle men -- the idea of course being that that will cost users of the market less money.”

Trading Firms

What may ultimately doom the ring is firms’ dwindling interest in trading there. The number of companies now entitled to transact there has shrunk from 17 firms in 1996 and more than 30 in the 1980s. Several companies are interested in joining the floor trading and they had been waiting for a decision on the ring’s future, Jones said in today’s interview. The bourse won’t offer new incentives to joining firms, he said.

While the LME accounts for more than 80% of global metal-futures trading, ring trades are down to about 5% of total volume excluding phone trades based on ring prices, according to the LME. Including the phone trades, the ring accounts for 12% of volume.

Loudest Sessions

Ring trading takes place between 11:40 a.m. and 5 p.m. It’s split into five-minute ring sessions for each metal with two longer sessions known as the “kerb,” during which all metals are traded at the same time. Official prices set in the second ring session are used by metals producers, consumers and merchants, while hedge funds and banks use closing prices established in the last kerb to calculate their open positions. These two sessions are the loudest, Patterson said.

The ring is different from traditional U.S. pits in which each contract is traded continuously throughout the day in its own dedicated pit. There are as many as 200 tradable dates per LME metal, according to the bourse. Some simultaneous buying and selling of contracts for different delivery dates, known as carry trades, can be done faster and in bigger amounts in the ring.

The LME declined to comment on the costs of running the ring. Ring-dealing members pay an annual fee of 55,000 pounds before expenses to maintain a floor staff. Running a ring- dealing team may cost 2 million to 4 million pounds a year, according to estimates by Mo Ahmadzadeh, a managing partner at Southold Capital LLC in New York. There are about 160 dealers, clerks, account executives and LME staff who work on the floor, according to the bourse.

Sawdust Circle

The ring goes back to the 1800s when metals merchants met in local coffee houses after the Royal Exchange, the trading center founded by Queen Elizabeth I, became too cramped. Merchants would draw a circle in the sawdust to trade tin from Malaya and copper from Chile. The benchmark three-month futures contract reflects the time it used to take to get those metals to London from Malaya and Chile.

The LME was formed in 1877 and was located above a hat shop in Lombard Court in London’s financial district. It grew quickly and moved to a specially built exchange on Whittington Avenue at the Leadenhall Market, where it remained for nearly a century. Dealers would transact around a big circular copper ashtray in the middle of the ring.

Passive Smoker

“I was a passive smoker for years,” said Malcolm Freeman, director of West Malling, England-based Kingdom Futures Ltd., who started as a clerk in the 1970s. “Dealers would very skillfully flick their cigarettes in a sitting position into the ashtray. God forbid if you missed. You were booed and you had to walk in the middle and pick it up and sit down again.”

Since 1994, the exchange has occupied a nondescript grey building on Leadenhall Street, a short walk from the Fenchurch Street and Liverpool Street stations where the many traders who hail from Essex, a suburban London county, can catch their evening trains.

A high proportion of traders and clerks live in the same few Essex towns, Nat Le Roux, an LME board member, wrote in his social anthropology dissertation for University College London in 2008. Many of them never attended university. Clerks are often recruited informally by senior traders through friends and family. Traders often go by nicknames and not all of them, at least in the past, were politically correct.

Trader Nicknames

For instance, a trader nicknamed “Tick” is the son of an ex-trader nicknamed “Bug” and the nephew of another ring employee nicknamed “Flea.”

“I look around the ring and I can see all these look- alikes of people that I knew 30 years ago -- these are their sons and nephews and daughters,” said Stefano D’Andrea, 51, a ring trader with New York-based INTL FCStone Inc. who started trading on the floor in the 1980s. “To young people, the ring looks like such a weird thing. It’s only been 15 years or so since all the other open outcry markets closed. To the basic member of the public this looks like a very unusual spectacle now.”

About the Author