CME To Gain From UK Court Ruling Against London Metal Exchange

March 31st, 2014 by Trefis Team
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Just weeks before the CME Group (NASDAQ:CME) planned to initiate aluminum trading on its London-based derivatives exchange, a British court ruling gave CME a pleasant surprise. Recent reports suggest that a London high court has ruled in favor Russian aluminum giant Rusal against the London Metal Exchange (LME), the largest metals trading venue in the world. In the last few years, major aluminum producers such as Alcoa (NYSE:AA) and Rusal have criticized the lack of transparency in the pricing of the metal on LME’s trading platform, which gave CME an ideal opportunity to commence the trading of aluminum contracts on its platform.

The supposed lack of transparency in pricing was caused due a time lag between the actual trading time and the delivery of physical aluminum, which caused the prices to fluctuate. LME attributed the time lag to long queues at warehouses and clearing venues, causing this difference in prices due to which LME proposed a warehousing solution. However, Alcoa management lashed out at LME and labeled its corrective plan as ‘counter-productive’.  [1]. Rusal also showed its discontent at LME’s efforts to revive the situation. [2] On being approached by both corporate users and producers of aluminum, CME planned to roll out a transparent trading platform on its London-based exchange. [3] The court’s ruling comes at a favorable time for CME, as traders, producers and corporate users are likely to be in favor of the transparent trading platform that CME plans to initiate.

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Court Ruling Comes At A Perfect Time For CME

CME initially planned to roll out foreign exchange (FX) based derivatives trading on its London-based exchange, but the plans were delayed for regulatory reasons. The company had a further setback when it faced some ‘technical issues‘ causing a further delay in starting its European operations. Even though CME has received approval from European regulators to open the London-based exchange, the company has yet to get approval to commence FX. CME’s FX trading will not be allowed to kick off on the company’s planned launch date unless it can convince regulators that its clearing members can physically settle the FX contracts. Due to the uncertainty in the starting time of FX trading in Europe, management decided to start aluminum trading on its London-based exchange.

However, taking on the market leader in an unfamiliar market will be a daunting task for the Chicago-based operator. Moreover, the delays caused in getting regulatory approvals meant that CME missed out on an opportunity to grab foothold in the growing European derivatives market. However, the court ruling against LME comes at an opportune time. CME’s major competitors such as IntercontinentalExchange (NYSE:ICE), NASDAQ OMX (NASDAQ:NDAQ) and Deutsche Börse Group (ETR:DB1) presently don’t have a presence in base metals trading. However, according to Reuters, CME may only have short-term gains with this news, as LME could find a way to circumvent the laws and forge ahead with aluminum trading. [4] However, the growing skepticism among investors, corporate users and producers of aluminium with the near-monopoly created by LME could have long-term implications which could in turn benefit CME. Taking a conservative estimate, if CME’s average daily trades of metal-based products increases by about 15% by the end of our forecast period, we could witness a 4-5% upside to our $70 price estimate for CME’s stock. There could be a further upside to our valuation if the company generates a higher transaction fee per traded contract in Europe compared to its U.S. rates.

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Notes:
  1. Alcoa Hits Out At LME Warehouse Plan, Financial Times, September 2013 [↩]
  2. Rusal Attacks LME Plan To Cut Metal Queue, Financial Times, September 2013 [↩]
  3. CME Takes On LME With Aluminium Contract, Financial Times, October 2013 [↩]
  4. LME ruling creates ‘perfect storm’ for CME’s aluminum bid, Reuters, March 2014 [↩]