LME announces changes to closing price methodology

The London Metal Exchange (LME) has announced a phased introduction of an evolved closing price methodology to some of its trading contracts. The change, which seems to weigh in favor of larger transactions made at the end of each day, will eventually affect how the closing price is determined for aluminum, lead, copper, zinc and nickel.

Calling trade in those five nonferrous metals “its most liquid contracts,” the LME says the pending change in pricing methodology is designed to bring more determinism, transparency and standardization to the closing price discovery process.

"Our pricing evolution journey began in 2021, when we adopted the current approach of discovering our lunchtime official prices (used mainly by the physical industry) in the LME Ring, and our afternoon closing prices [used more by financial participants] on our electronic LMEselect platform," says Matthew Chamberlain, CEO of the LME. "This division has worked well, and allows us to further evolve our closing price methodology—a key request from many of our financial market users—while maintaining Ring-based official price discovery.

“We will now be phasing in the implementation from January 2024 to ensure participants have adequate time to prepare for the changes.”

Aluminum and lead closing prices will be determined with the new methodology starting Jan. 22, 2024, while copper, zinc and nickel will follow March 18, 2024.

The LME says the volume-weighted average price (VWAP) methodology to be phased in will calculate the average price of trades over the five-minute pricing window according to the volume of contracts traded. Therefore, the closing price will represent all of the trades that take place over the pricing window, with each trade’s influence on the price being proportionate to its size.

Additionally, if a five-lot minimum volume requirement (MVR) is not met, the price instead will be calculated using a time-weighted average price (TWAP) over the pricing window.

As the LME has gathered information and surveyed stakeholders to make changes to its contract offerings, nonferrous recyclers who hedge metals pricing regularly have urged the LME to consider the needs of physical traders as well as financial players.

Much of that concern involves any switch from the current contingent variation model (CVM) for traders taking a hedging position to a realized variation model (RVM), which is widely used in other trading exchanges.

“For the most part, I don’t know too many people in the trade, the physical market, who want to deal with RVM and settlements on a daily basis,” said Mark Sellier, president of Hong Kong-based Global Metals Network, at a Bureau of International Recycling online session in 2021.

Reached this week by Recycling Today, another participant in that 2021 session, veteran trader and BIR volunteer Michael Lion, says, “The [closing price] calculation basis being proposed of itself should not necessarily have significant implications for scrap hedgers.”

But, a change in one methodology to stimulate financial sector involvement could lead to others.

“The underlying concern would be if this subsequently extrapolates into re-consideration by the LME of possibly again visiting the proposal raised in their 2021 discussion paper of changing margin requirements on the LME to [the] RVM methodology," Lion adds.

Like Sellier, Lion says independent and medium-sized recycling and trading firms remain wary. “A change to that methodology could significantly detrimentally impact the recycling industry in respect of recycling hedgers’ ability to obtain vital credit lines from LME brokers to fund the volatile price changes that can impact hedge positions that protect the hedger’s underlying physical metals position," he adds.

In a news release announcing the closing price change, LME says, “A number of respondents to the consultation noted their desire for trade-at-settlement (TAS) contracts to be implemented alongside the VWAP methodology. While TAS is not, in the LME’s view, a prerequisite for the new methodology, the LME plans to introduce TAS functionality for three-month contracts alongside the launch of its new trading platform in 2024 and will continue to review the possibility of further expanding this functionality.”

In the 42-page 2021 discussion paper, the LME characterized TAS as providing “increased transparency of the pricing methodology.” However, the LME added regarding TAS, “The competitive position of Category 1 members may be impacted by the move away from the Ring, which could change the nature of the relationship between Category 1 members, other market participants and the LME itself.”

LME Category 1 members are those who have access to the trading Ring in London, in addition to electronic services.