Post by Sapphire Capital on Jul 12, 2008 22:49:08 GMT 4
LONDON METAL EXCHANGE
ExD05203
---------From Executive Director: Regulation and Compliance
To: ALL MEMBERS
Ref: 05/377 : A370 : R016
Date: 15 December 2005
Subject: LENDING GUIDANCE FOR LME METALS
Summary
1 Market Aberrations: The Way Forward was published by the Exchange
in October 1998 as an attachment to LME notice 98/363 : A351 : W072.
Paragraph 13.24 of the Market Aberrations document sets out the Lending
Guidance that applies to the holders of dominant long positions in the LME
metal markets.
2 At its meeting on the 15 December 2005 the board of the LME decided
to formalise with immediate effect the rules and procedures relating to the
operation of the Lending Guidance.
3 Schedule 1 to this notice sets out clarification and explanation of a
number of practical aspects of the Lending Guidance.
4 Schedule 2 sets out new rules that explicitly require members to
comply with the Lending Guidance and deal with any actual or likely failure by
a non-member to abide by the Lending Guidance.
Background
5 The market aberrations document dealt with a number of issues
relating to the LME metal markets and their regulation. The document was
the result of a consultation process that started in October 1997 and included
the Solutions to Market Aberrations consultation document (attached to LME
notice 98/007 : A007 : W011) published in March 1998. The full Market
Aberrations document is available on the LME website www.lme.com in a
printable format.
6 The Solutions to Market Aberrations consultation document proposed a
number of mechanisms for dealing with dominant positions in the LME metal
ExD05203 2
markets. The Lending Guidance was formulated by the Board as the solution
that best fitted the structure of the LME metal markets.
7 Prior to the introduction of the Lending Guidance, the Exchange’s
response to the effect of dominant positions in the metal markets was to
introduce backwardation limits. However, there were two aspects of this use
of backwardation limits that were heavily criticised. First, the backwardation
limits were not specific to dominant position holders and obliged all long
position holders to lend their positions for a day at no more than a premium
set by the Exchange. Secondly, the need to announce the imposition of the
backwardation limits with immediate effect, gave the markets no notice and
made the application of backwardation limits unpredictable.
8 The Lending Guidance addresses both of these concerns. It creates
an obligation on the holder or holders of a dominant position to lend at the
required levels but creates no obligation on the holder of a long position that is
not dominant. The market aberrations document provides that a dominant
position can be created by two or more parties acting together. The
circumstances in which the Lending Guidance takes effect are known in
advance which introduces an element of predictability in the event that there is
a dominant position in any of the metal markets.
9 It has been argued before the LME Special Committee that the Lending
Guidance is in itself the cause of market distortion where warranted stocks are
low. In the Committee's view, if there is such distortion, it is minimal and is
more than offset by the maintenance of orderly trading for the nearest prompt
dates.
10 Compliance with the Lending Guidance is an accepted market practice
under the FSA’s Code of Market Conduct and under the Market Abuse
Directive.
Clarification and Explanation
11 The terms of the Lending Guidance are clear in their intent and in the
behaviour expected of a dominant position holder. However, the Board
recognises that trading on the LME metal markets requires a certain level of
expertise and that it would be useful for participants in the market if the
Exchange set out clarification and explanation of a number of practical
aspects of the Lending Guidance. These are set out in Schedule 1. A draft of
Schedule 1 was circulated to category 1, 2 and 4 members for comment. The
final text of Schedule 1 has benefited from the comments that were made.
New Rules
12 The Lending Guidance sets out the behaviour required of holders of
dominant long positions in the LME metal markets. The Lending Guidance is
designed to deal with the effect of dominant positions in the nearby prompt
ExD05203 3
dates so as to maintain order in those metal markets. Deliberate failure to
comply with the Lending Guidance would expose a dominant position holder
to a charge that it was attempting to create disorder in the market or was
attempting to manipulate the market. The new rules set out in Schedule 2 are
being introduced by the Board in order to reinforce the importance of the
Lending Guidance in maintaining order in the LME metal markets. The new
rules are without prejudice to the Special Committee’s powers to act under
Regulation 15 of the Trading Regulations.
Diarmuid O’Hegarty
cc: Board directors
Special Committee
ExD05203 4
Schedule 1
LENDING GUIDANCE
CLARIFICATION AND EXPLANATION
15 DECEMBER 2005
LENDING GUIDANCE
1 Paragraph 13.24 of Market Aberrations: The Way Forward (published
by the Exchange in October 1998) sets out the terms of the Lending Guidance
as follows:-
If at any time a member or client holds 50% or more of the warrants
and/or cash today/cash positions in relation to stocks, he should be
prepared to lend, if asked, at no more than a premium of ½% of the
cash price for a day. After five successive days, he should be prepared
to lend, if asked, at no more than a premium of ¼% of the cash price
for a day.
If at any time a member or client holds 80% or more of the warrants
and/or cash today/cash positions in relation to stocks, he should be
prepared to lend, if asked, at no more than a premium of ¼% of the
cash price for a day. After five successive days, the maximum
premium would fall to 0.15%.
[c] If at any time a member or client holds 90% or more of the warrants
and/or cash today/cash positions in relation to stocks, he should be
prepared to lend, if asked, at no more than the cash price.
[d] As with the publication of large position information, in determining the
application of the guidelines, it would be appropriate for the LME to
aggregate the positions of a client across all brokers in reaching its
estimate of dominant positions. Likewise it would be appropriate to
aggregate the positions of a member, its related group companies and
its clients unless the firm could demonstrate that the positions were
independent.
HOW TO CALCULATE A DOMINANT POSITION
2 The basis of a relevant position in any metal for the purposes of the
Lending Guidance is the total of a person’s warrant holding (“W”), net Tom
trading positions (“T”) and net cash trading positions (“C”). This is referred to
as the net WTC position and is expressed in lots. That net WTC position is
divided by the number of live LME warrants for that metal. The result of (W +
ExD05203 5
T + C) ÷ (live warrants) is expressed as a percentage to two decimal places.
For example, a warrant position of 123 warrants, a net Tom position of 456
lots and a net cash position of 789 lots will equal 1,368 lots. If the total
number of live LME warrants were 1,500, the WTC position would be 91.20%.
(123 + 456 + 789)
1,500
= 91.20%
3 The denominator used is live warrants rather than total stock. Total
LME stock in each metal is the sum of live warrants and cancelled stock. This
means that if a dominant position holder reduces his warrant holding by
cancelling warrants, he will also be reducing the denominator used to
calculate the size of his dominant position.
4 The resulting percentage forms the basis for calculating the number of
lots that a dominant position holder must be prepared to lend. The Lending
Guidance treats a WTC position of 50% and above as dominant. This means
that a position holder is subject to the Lending Guidance until his WTC
position is reduced to 49.99%. For practical reasons, these percentages need
to be expressed in lots as whole numbers. In the above example, 50% of
1500 lots equals 750 lots. Therefore, 749 lots equals less than 50%. The
dominant WTC position (123 + 456 + 789) equals 1,368 lots. The holder
would have to be prepared to lend 619 lots to reduce his WTC position down
to 749 lots. Expressed as percentages, this means that the dominant position
holder must be prepared to lend 41.21%, rounded up to the nearest lot.
5 The figures used in calculating a WTC position are those reported by
members to the Exchange by 8.30am each business day. The figures relate
to the WTC positions as at the close of business on the previous business
day. Each member’s reports separately identify the W, T and C positions held
on behalf of the member and the W, T and C positions held by each of its
clients, including any of the member’s affiliate companies. The Exchange is
able to aggregate the WTC positions held by a single client or group of
connected clients across a number of members. LME notice 01/122, dated 23
March 2001, sets out the Exchange’s approach for attributing and aggregating
warrant holdings for the purposes of the Lending Guidance.
6 The net WTC positions are divided by the number of live warrants as at
the same point in time, the close of business the previous day. The live
warrant figures used are the same as those included in the stock figures
published by the Exchange at 9.00am each business day.
7 As WTC positions are calculated each morning on the basis of figures
as at the close of business on the previous day, the reported T trading
position will have become a delivery obligation for that day and the reported C
position will have become a Tom position for that day. In order to reduce that
reported WTC position in line with the Lending Guidance, the dominant
position holder should be prepared “to lend” Tom/next (or one of the Tom date
carries).
ExD05203 6
HOW A DOMINANT POSITION TRIGGERS THE LENDING GUIDANCE
8 The Lending Guidance operates in three effective bands. The first is
where a WTC position is 50% or more but less than 80% of live warrants. The
second band is where a WTC position is 80% or more but less than 90% of
live warrants. The third band is where a WTC position is 90% or more of live
warrants.
9 The effect of this banding is that where a person’s WTC position is
above 90% of live warrants he should be prepared to lend for a day:
(a) at no premium (i.e. “level”) a sufficient number of lots to reduce his
position below 90%;
(b) at a premium of no more than ¼% of the cash price a sufficient number
of lots to reduce his position below 80%; and
(c) at a premium of no more than ½% of the cash price a sufficient number
of lots to reduce his position below 50%.
10 The cash price used to calculate the premium each business day is the
LME official cash settlement price published the previous business day. The
maximum premium percentage is expressed as a US dollar amount rounded
down to the nearest cent.
11 In the following example the notional WTC figures are the same as
those used in paragraphs 2 and 4 above, i.e. the dominant position of 91.20%
requires the holder to be prepared to lend 619 lots to reduce his position
below 50%. The notional cash price being used is $2,000.
Lending Guidance
Percentage Bands
Position Holder’s
Dominance in lots
Maximum
Premium
90% and above 19 level
80% to 89.99% 150 $5.00
50% to 79.99% 450 $10.00
total 619
12 The Lending Guidance states that a dominant position holder “should
be prepared to lend, if asked”. This expression means that the dominant
position holder should respond to demand in the market for borrowing at the
premium set by the Lending Guidance. The dominant position holder is not
obliged to lend if the market demand for Tom/next borrowing is at a
backwardation premium below that specified by the lending guidance. In the
example at paragraph 11 above, the dominant position holder should be
prepared:-
(a) to lend at least 19 lots at level if the Tom/next backwardation premium
bid in the market reaches level. If the backwardation premium bid in
ExD05203 7
the market stays below $5.00 he is not obliged to lend more than those
19 lots;
(b) to lend an additional 150 lots at a premium of no more than $5.00 if the
backwardation premium bid in the market reaches $5.00. If the
backwardation premium bid in the market stays below $10.00 he will
not be obliged to lend more than 169 lots (i.e. 150 lots at no more than
$5.00 and 19 lots at no more than level);
(c) to lend an additional 450 lots at a premium of no more than $10.00 if
the backwardation premium bid in the market reaches $10.00. Once
he has reduced his position below 50% he is no longer obliged to lend
and those who wish to borrow will have to bid out the price until
someone is prepared to lend.
13 If the dominant position holder chooses to continue lending, the
maximum backwardation premium does not apply to any additional lending
done after he has reduced his position below 50%.
14 Lending Tom/next involves selling for the Tom Prompt Date and buying
for the cash Prompt Date. Where a dominant position holder reduces his
WTC position on one day by lending Tom/next, he will be adding to his C
position for the purposes of calculating his WTC position the next morning.
This explains how a person may abide by the Lending Guidance but maintain
a dominant position on successive days.
15 Dominant positions are also subject to reduced maximum premiums
after the dominant position has been held for more than five successive
business days. On the sixth and subsequent successive business days a
WTC position of 50% or more but less than 80% of live warrants is subject to
a maximum premium of ¼% of the cash price. On the sixth and subsequent
successive days a WTC position of 80% or more but less than 90% of live
warrants is subject to a maximum premium of 0.15% of the cash price. The
purpose of this reduction in the maximum premium is to take account of the
effect of a dominant position over time.
16 If, for example, a dominant position has fluctuated between 60% and
85% for five successive days, the reduced maximum premium of ¼% will
apply to the WTC position of 50% or more but less than 80%; no reduction will
apply to the position of 80% or more until that has been maintained for five
successive days. The calculation of successive business days recommences
following any day on which the Tom/next market in the relevant metal did not
trade at a backwardation but only traded at level or at a contango.
HOW TO COMPLY WITH THE LENDING GUIDANCE
17 The Lending Guidance is an obligation placed on those who hold a
dominant long position in any of the LME metal markets. The holder of the
dominant position is ultimately responsible for his own compliance with the
Lending Guidance. This is the case both for members and non-members. In
ExD05203 8
the case of a non-member, compliance with the Lending Guidance requires
the non-member to give appropriate instructions to one or more of his brokers.
18 The LME Compliance Department calculates dominant positions on the
basis of position reports submitted electronically by members. Members must
notify the Exchange of the identity of all position holders and of any
connections between two or more position holders. Details of new account
holders must be notified to the Exchange before that new account starts
trading. Where the LME Compliance Department identifies a dominant
position, the holder of that position will be contacted both to confirm the
figures used to calculate the dominant position and to discuss any steps to be
taken. These steps could include adjustments to a WTC position to account
for OTC business being brought on Exchange that day. Many non-members
prefer to have these discussions direct with the LME Compliance Department
rather than go through one or more of their brokers. Although, both members
and non-members may discuss their WTC positions with the LME Compliance
Department, the holder of a dominant position is best placed to know the size
of his own WTC positions. Once the LME stock figures are published at
9.00am, a position holder is able to calculate whether or not his net WTC
position triggers the Lending Guidance.
19 Increases or decreases in the LME warrant figures from the previous
day’s figures may affect whether a WTC position is dominant or whether the
dominance exceeds the 80% or 90% thresholds and by how many lots. For
this reason a dominant position holder is entitled to wait until the LME stock
figures are published before complying with the Lending Guidance. However,
if a dominant position holder chooses to lend before 9.00am, that lending
must be in compliance with the Lending Guidance. If there has been a
material change in the live warrant figures, the dominant position holder may
have to adjust some of the trades he did before the LME stock figures were
published in order to ensure that his lending has complied with the Lending
Guidance.
20 Lending in compliance with the Lending Guidance must be done in the
correct order. If a dominant WTC position is above 90%, the position holder
must lend at level a sufficient number of lots to bring his position below 90%
before he may lend at a premium of ¼% of the cash price. Similarly, he must
lend at a premium of no more than ¼% of the cash price a sufficient number
of lots to bring his position below 80% before he may lend at a premium of
½% of the cash price. He must have reduced his position below 50% before
he may lend at a premium greater than those specified by the Lending
Guidance.
21 The LME provides three forums for trading: in the ring, on LME Select
and on the telephone. A dominant position holder should be prepared to
respond to requests for borrowing in all three forums. A dominant position
holder is not obliged to verify if the person borrowing from him is doing so to
cover a short. However, the purpose of the Lending Guidance is to address
the effect of his dominant position on those who are short. It would be an
abuse of the Lending Guidance for a dominant position holder to contrive to
ExD05203 9
lend to another person at the specified premium with the intention that that
other person could lend in the market at a higher premium.
Lending on LME Select
22 A bid on LME Select is a request to the market. A dominant position
holder must respond to bids on LME Select where those bids reach the
premium at which the dominant position holder must be prepared to lend. The
mechanisms for ensuring orderly trading on LME Select mean that a lower
offer entered into the system will trade with an existing higher bid. If there is a
bid in LME Select that is at a higher premium than that prescribed by the
Lending Guidance, a dominant position holder must trade with that bid to
identify the borrower and subsequently adjust the price back to the correct
premium. This adjustment cannot be done on LME Select but requires a
reversal trade and a new trade at the correct premium to be negotiated on the
telephone. If the circumstances suggest that bids for Tom/next borrowing on
LME Select will be higher that the backwardation premiums at which the
dominant position holder will be obliged to lend, the dominant position holder
should behave prudently and consider placing offers on LME Select to
anticipate bidding. This will avoid the need for adjustment trades.
23 If the dominant position holder is not a clearing member, he must make
arrangements with his broker to take the necessary steps to respond to bids
on LME Select and to make adjustments where necessary.
Lending in the Ring
24 A bid in the ring is also a request to the market. The first ring session
for each metal is the last opportunity to lend or borrow Tom/next by open
outcry. A dominant position holder who has not reduced his WTC position
below 50% by the start of the first ring must respond to bids in the ring where
those bids reach the premium at which the dominant position holder must be
prepared to lend.
25 The mechanisms for ensuring orderly trading in the ring mean that
once a bid to borrow has been made a lender must either accept that bid or
make a higher offer. It is a breach of the ring trading regulations to make an
offer that is lower than a prevailing bid. If a dominant position holder’s WTC
position remains at 50% or above by the start of the first ring, he must ensure
that he responds to bids and that any lending he does is at premiums no
higher than the premium prescribed by the Lending Guidance. In order to
ensure this and to abide by the ring trading regulations, it may be necessary
for the dominant position holder to offer to lend. If the circumstances suggest
that Tom/next trading in the ring is likely to start at higher premiums, the
dominant position holder should be prepared to open the ring with an offer
before any bid is made.
26 If the dominant position holder in these circumstances is not a ring
dealing member, he must make arrangements in good time for a ring dealing
member to effect the necessary lending on his behalf.
ExD05203 10
BROKERS INSTRUCTED BY DOMINANT CLIENTS
27 There are a number of considerations that a member must take into
account when acting for a client who is dominant. In particular, the member
must ensure that his actions comply with the FSA Code of Market Conduct
and the FSA Conduct of Business Rules.
28 If a member is instructed by a client to lend a number of lots at a
particular backwardation premium, that instruction is an order for the purposes
of FSA rules. In executing that order, the member must manage any conflicts
of interest, must not misuse customer information or breach the FSA Code of
Market Conduct. For example, it is clearly wrong for a member who is acting
for a dominant position holder to borrow from that dominant position holder, or
to collude with someone else to borrow from that dominant position holder, at
the premium prescribed by the Lending Guidance with a view to lending in the
market at a higher premium. Nothing that the member does should frustrate
the dominant client’s willingness or ability to lend to bidders in the market.
29 A member who receives an order from a client to lend in accordance
with the Lending Guidance may already have orders from other clients to
borrow. In situations like that, the member must be careful to comply with the
FSA’s rules on order priority and fair allocation. In those circumstances the
member must also keep in mind the responsibility on a dominant position
holder to respond to bids on LME Select or in the ring. If he receives an order
from a client to lend in accordance with the Lending Guidance and already
has a bid on LME Select that represents a client wishing to borrow he should
cancel that bid on Select before crossing the borrowing client’s order with the
dominant client’s lending order.
30 When a member receives instructions from a client to lend in
accordance with the Lending Guidance, that member will be in possession of
privileged customer information. The member must be careful not to take
advantage of that information and should give priority to his own clients who
are short and to bids on LME Select or in the ring over his house shorts.
CONCLUSION
31 Those who would like any further clarification or explanation of the
Lending Guidance should contact the Market Surveillance department at the
Exchange.
ExD05203 11
Schedule 2
Amendments to
part 1, Definitions, and
part 3 Trading Regulations
of the
LME rules and regulations
Part 1, Definitions
“Lending Guidance” paragraph 13.24 of Market Aberrations: The
Way Forward, published by the Exchange in
October 1998, setting out the behaviour
required of the holders of dominant long
positions in the Exchange’s metal markets,
including any clarification or explanation of that
behaviour issued by the Exchange from time to
time;
Part 3, Trading Regulations
16. POSITION LIMITS FOR PLASTICS CONTRACTS AND LENDING
GUIDANCE FOR METALS
16.1 [no change]
16.2 [no change]
16.3 Members shall comply with the Lending Guidance and shall co-operate
with the Exchange to ensure that each of their Clients shall comply with
the Lending Guidance.
16.4 Where the Exchange has reasonable cause to suspect that a Client
has failed or is likely to fail to comply with the Lending Guidance, the
Exchange may give directions to one or more Members with whom that
Client has Client Contracts to take action designed to make the same
number of lots available for borrowing in the market as would have
been the case if the Client were prepared to abide by the Lending
Guidance. Such directions to a Member may include but are not
limited to:-
(a) lending or offering to lend, at no more than a level premium, the
number of Exchange Contract positions equal to or less than the
Client’s long position holding of 90% or more as calculated by
the Exchange in accordance with the Lending Guidance; and/or
ExD05203 12
(b) lending or offering to lend, at no more than a premium of 0.50%
of the previous day’s Cash price, the number of Exchange
Contract positions equal to or less than the Client’s long position
holding of 80% or more but less than 90% as calculated by the
Exchange in accordance with the Lending Guidance; and/or
(c) lending or offering to lend, at no more than a premium of 0.25%
of the previous day’s Cash price, the number of Exchange
Contract positions equal to or less than the Client’s long position
holding of 50% or more but less than 80% as calculated by the
Exchange in accordance with the Lending Guidance; and/or
(b) trading out of sufficient Client Contract positions with that Client
to reduce that Member’s (or, if two or more Members are
directed, those Members') net exposure to that Client in line with
the action taken in compliance with the directions under (a) to (c)
above.
16.5 Compliance with the Lending Guidance is subject to the power of the
Special Committee to take steps or give directions under Regulations
15.1 to 15.3 above. Without prejudice to the generality of Regulations
15.1 to 15.3 above, such steps or directions may include suspending,
amending or supplementing the Lending Guidance for such period or in
respect of such metals as the Special Committee in its absolute
discretion deems necessary.
ExD05203
---------From Executive Director: Regulation and Compliance
To: ALL MEMBERS
Ref: 05/377 : A370 : R016
Date: 15 December 2005
Subject: LENDING GUIDANCE FOR LME METALS
Summary
1 Market Aberrations: The Way Forward was published by the Exchange
in October 1998 as an attachment to LME notice 98/363 : A351 : W072.
Paragraph 13.24 of the Market Aberrations document sets out the Lending
Guidance that applies to the holders of dominant long positions in the LME
metal markets.
2 At its meeting on the 15 December 2005 the board of the LME decided
to formalise with immediate effect the rules and procedures relating to the
operation of the Lending Guidance.
3 Schedule 1 to this notice sets out clarification and explanation of a
number of practical aspects of the Lending Guidance.
4 Schedule 2 sets out new rules that explicitly require members to
comply with the Lending Guidance and deal with any actual or likely failure by
a non-member to abide by the Lending Guidance.
Background
5 The market aberrations document dealt with a number of issues
relating to the LME metal markets and their regulation. The document was
the result of a consultation process that started in October 1997 and included
the Solutions to Market Aberrations consultation document (attached to LME
notice 98/007 : A007 : W011) published in March 1998. The full Market
Aberrations document is available on the LME website www.lme.com in a
printable format.
6 The Solutions to Market Aberrations consultation document proposed a
number of mechanisms for dealing with dominant positions in the LME metal
ExD05203 2
markets. The Lending Guidance was formulated by the Board as the solution
that best fitted the structure of the LME metal markets.
7 Prior to the introduction of the Lending Guidance, the Exchange’s
response to the effect of dominant positions in the metal markets was to
introduce backwardation limits. However, there were two aspects of this use
of backwardation limits that were heavily criticised. First, the backwardation
limits were not specific to dominant position holders and obliged all long
position holders to lend their positions for a day at no more than a premium
set by the Exchange. Secondly, the need to announce the imposition of the
backwardation limits with immediate effect, gave the markets no notice and
made the application of backwardation limits unpredictable.
8 The Lending Guidance addresses both of these concerns. It creates
an obligation on the holder or holders of a dominant position to lend at the
required levels but creates no obligation on the holder of a long position that is
not dominant. The market aberrations document provides that a dominant
position can be created by two or more parties acting together. The
circumstances in which the Lending Guidance takes effect are known in
advance which introduces an element of predictability in the event that there is
a dominant position in any of the metal markets.
9 It has been argued before the LME Special Committee that the Lending
Guidance is in itself the cause of market distortion where warranted stocks are
low. In the Committee's view, if there is such distortion, it is minimal and is
more than offset by the maintenance of orderly trading for the nearest prompt
dates.
10 Compliance with the Lending Guidance is an accepted market practice
under the FSA’s Code of Market Conduct and under the Market Abuse
Directive.
Clarification and Explanation
11 The terms of the Lending Guidance are clear in their intent and in the
behaviour expected of a dominant position holder. However, the Board
recognises that trading on the LME metal markets requires a certain level of
expertise and that it would be useful for participants in the market if the
Exchange set out clarification and explanation of a number of practical
aspects of the Lending Guidance. These are set out in Schedule 1. A draft of
Schedule 1 was circulated to category 1, 2 and 4 members for comment. The
final text of Schedule 1 has benefited from the comments that were made.
New Rules
12 The Lending Guidance sets out the behaviour required of holders of
dominant long positions in the LME metal markets. The Lending Guidance is
designed to deal with the effect of dominant positions in the nearby prompt
ExD05203 3
dates so as to maintain order in those metal markets. Deliberate failure to
comply with the Lending Guidance would expose a dominant position holder
to a charge that it was attempting to create disorder in the market or was
attempting to manipulate the market. The new rules set out in Schedule 2 are
being introduced by the Board in order to reinforce the importance of the
Lending Guidance in maintaining order in the LME metal markets. The new
rules are without prejudice to the Special Committee’s powers to act under
Regulation 15 of the Trading Regulations.
Diarmuid O’Hegarty
cc: Board directors
Special Committee
ExD05203 4
Schedule 1
LENDING GUIDANCE
CLARIFICATION AND EXPLANATION
15 DECEMBER 2005
LENDING GUIDANCE
1 Paragraph 13.24 of Market Aberrations: The Way Forward (published
by the Exchange in October 1998) sets out the terms of the Lending Guidance
as follows:-
If at any time a member or client holds 50% or more of the warrants
and/or cash today/cash positions in relation to stocks, he should be
prepared to lend, if asked, at no more than a premium of ½% of the
cash price for a day. After five successive days, he should be prepared
to lend, if asked, at no more than a premium of ¼% of the cash price
for a day.
If at any time a member or client holds 80% or more of the warrants
and/or cash today/cash positions in relation to stocks, he should be
prepared to lend, if asked, at no more than a premium of ¼% of the
cash price for a day. After five successive days, the maximum
premium would fall to 0.15%.
[c] If at any time a member or client holds 90% or more of the warrants
and/or cash today/cash positions in relation to stocks, he should be
prepared to lend, if asked, at no more than the cash price.
[d] As with the publication of large position information, in determining the
application of the guidelines, it would be appropriate for the LME to
aggregate the positions of a client across all brokers in reaching its
estimate of dominant positions. Likewise it would be appropriate to
aggregate the positions of a member, its related group companies and
its clients unless the firm could demonstrate that the positions were
independent.
HOW TO CALCULATE A DOMINANT POSITION
2 The basis of a relevant position in any metal for the purposes of the
Lending Guidance is the total of a person’s warrant holding (“W”), net Tom
trading positions (“T”) and net cash trading positions (“C”). This is referred to
as the net WTC position and is expressed in lots. That net WTC position is
divided by the number of live LME warrants for that metal. The result of (W +
ExD05203 5
T + C) ÷ (live warrants) is expressed as a percentage to two decimal places.
For example, a warrant position of 123 warrants, a net Tom position of 456
lots and a net cash position of 789 lots will equal 1,368 lots. If the total
number of live LME warrants were 1,500, the WTC position would be 91.20%.
(123 + 456 + 789)
1,500
= 91.20%
3 The denominator used is live warrants rather than total stock. Total
LME stock in each metal is the sum of live warrants and cancelled stock. This
means that if a dominant position holder reduces his warrant holding by
cancelling warrants, he will also be reducing the denominator used to
calculate the size of his dominant position.
4 The resulting percentage forms the basis for calculating the number of
lots that a dominant position holder must be prepared to lend. The Lending
Guidance treats a WTC position of 50% and above as dominant. This means
that a position holder is subject to the Lending Guidance until his WTC
position is reduced to 49.99%. For practical reasons, these percentages need
to be expressed in lots as whole numbers. In the above example, 50% of
1500 lots equals 750 lots. Therefore, 749 lots equals less than 50%. The
dominant WTC position (123 + 456 + 789) equals 1,368 lots. The holder
would have to be prepared to lend 619 lots to reduce his WTC position down
to 749 lots. Expressed as percentages, this means that the dominant position
holder must be prepared to lend 41.21%, rounded up to the nearest lot.
5 The figures used in calculating a WTC position are those reported by
members to the Exchange by 8.30am each business day. The figures relate
to the WTC positions as at the close of business on the previous business
day. Each member’s reports separately identify the W, T and C positions held
on behalf of the member and the W, T and C positions held by each of its
clients, including any of the member’s affiliate companies. The Exchange is
able to aggregate the WTC positions held by a single client or group of
connected clients across a number of members. LME notice 01/122, dated 23
March 2001, sets out the Exchange’s approach for attributing and aggregating
warrant holdings for the purposes of the Lending Guidance.
6 The net WTC positions are divided by the number of live warrants as at
the same point in time, the close of business the previous day. The live
warrant figures used are the same as those included in the stock figures
published by the Exchange at 9.00am each business day.
7 As WTC positions are calculated each morning on the basis of figures
as at the close of business on the previous day, the reported T trading
position will have become a delivery obligation for that day and the reported C
position will have become a Tom position for that day. In order to reduce that
reported WTC position in line with the Lending Guidance, the dominant
position holder should be prepared “to lend” Tom/next (or one of the Tom date
carries).
ExD05203 6
HOW A DOMINANT POSITION TRIGGERS THE LENDING GUIDANCE
8 The Lending Guidance operates in three effective bands. The first is
where a WTC position is 50% or more but less than 80% of live warrants. The
second band is where a WTC position is 80% or more but less than 90% of
live warrants. The third band is where a WTC position is 90% or more of live
warrants.
9 The effect of this banding is that where a person’s WTC position is
above 90% of live warrants he should be prepared to lend for a day:
(a) at no premium (i.e. “level”) a sufficient number of lots to reduce his
position below 90%;
(b) at a premium of no more than ¼% of the cash price a sufficient number
of lots to reduce his position below 80%; and
(c) at a premium of no more than ½% of the cash price a sufficient number
of lots to reduce his position below 50%.
10 The cash price used to calculate the premium each business day is the
LME official cash settlement price published the previous business day. The
maximum premium percentage is expressed as a US dollar amount rounded
down to the nearest cent.
11 In the following example the notional WTC figures are the same as
those used in paragraphs 2 and 4 above, i.e. the dominant position of 91.20%
requires the holder to be prepared to lend 619 lots to reduce his position
below 50%. The notional cash price being used is $2,000.
Lending Guidance
Percentage Bands
Position Holder’s
Dominance in lots
Maximum
Premium
90% and above 19 level
80% to 89.99% 150 $5.00
50% to 79.99% 450 $10.00
total 619
12 The Lending Guidance states that a dominant position holder “should
be prepared to lend, if asked”. This expression means that the dominant
position holder should respond to demand in the market for borrowing at the
premium set by the Lending Guidance. The dominant position holder is not
obliged to lend if the market demand for Tom/next borrowing is at a
backwardation premium below that specified by the lending guidance. In the
example at paragraph 11 above, the dominant position holder should be
prepared:-
(a) to lend at least 19 lots at level if the Tom/next backwardation premium
bid in the market reaches level. If the backwardation premium bid in
ExD05203 7
the market stays below $5.00 he is not obliged to lend more than those
19 lots;
(b) to lend an additional 150 lots at a premium of no more than $5.00 if the
backwardation premium bid in the market reaches $5.00. If the
backwardation premium bid in the market stays below $10.00 he will
not be obliged to lend more than 169 lots (i.e. 150 lots at no more than
$5.00 and 19 lots at no more than level);
(c) to lend an additional 450 lots at a premium of no more than $10.00 if
the backwardation premium bid in the market reaches $10.00. Once
he has reduced his position below 50% he is no longer obliged to lend
and those who wish to borrow will have to bid out the price until
someone is prepared to lend.
13 If the dominant position holder chooses to continue lending, the
maximum backwardation premium does not apply to any additional lending
done after he has reduced his position below 50%.
14 Lending Tom/next involves selling for the Tom Prompt Date and buying
for the cash Prompt Date. Where a dominant position holder reduces his
WTC position on one day by lending Tom/next, he will be adding to his C
position for the purposes of calculating his WTC position the next morning.
This explains how a person may abide by the Lending Guidance but maintain
a dominant position on successive days.
15 Dominant positions are also subject to reduced maximum premiums
after the dominant position has been held for more than five successive
business days. On the sixth and subsequent successive business days a
WTC position of 50% or more but less than 80% of live warrants is subject to
a maximum premium of ¼% of the cash price. On the sixth and subsequent
successive days a WTC position of 80% or more but less than 90% of live
warrants is subject to a maximum premium of 0.15% of the cash price. The
purpose of this reduction in the maximum premium is to take account of the
effect of a dominant position over time.
16 If, for example, a dominant position has fluctuated between 60% and
85% for five successive days, the reduced maximum premium of ¼% will
apply to the WTC position of 50% or more but less than 80%; no reduction will
apply to the position of 80% or more until that has been maintained for five
successive days. The calculation of successive business days recommences
following any day on which the Tom/next market in the relevant metal did not
trade at a backwardation but only traded at level or at a contango.
HOW TO COMPLY WITH THE LENDING GUIDANCE
17 The Lending Guidance is an obligation placed on those who hold a
dominant long position in any of the LME metal markets. The holder of the
dominant position is ultimately responsible for his own compliance with the
Lending Guidance. This is the case both for members and non-members. In
ExD05203 8
the case of a non-member, compliance with the Lending Guidance requires
the non-member to give appropriate instructions to one or more of his brokers.
18 The LME Compliance Department calculates dominant positions on the
basis of position reports submitted electronically by members. Members must
notify the Exchange of the identity of all position holders and of any
connections between two or more position holders. Details of new account
holders must be notified to the Exchange before that new account starts
trading. Where the LME Compliance Department identifies a dominant
position, the holder of that position will be contacted both to confirm the
figures used to calculate the dominant position and to discuss any steps to be
taken. These steps could include adjustments to a WTC position to account
for OTC business being brought on Exchange that day. Many non-members
prefer to have these discussions direct with the LME Compliance Department
rather than go through one or more of their brokers. Although, both members
and non-members may discuss their WTC positions with the LME Compliance
Department, the holder of a dominant position is best placed to know the size
of his own WTC positions. Once the LME stock figures are published at
9.00am, a position holder is able to calculate whether or not his net WTC
position triggers the Lending Guidance.
19 Increases or decreases in the LME warrant figures from the previous
day’s figures may affect whether a WTC position is dominant or whether the
dominance exceeds the 80% or 90% thresholds and by how many lots. For
this reason a dominant position holder is entitled to wait until the LME stock
figures are published before complying with the Lending Guidance. However,
if a dominant position holder chooses to lend before 9.00am, that lending
must be in compliance with the Lending Guidance. If there has been a
material change in the live warrant figures, the dominant position holder may
have to adjust some of the trades he did before the LME stock figures were
published in order to ensure that his lending has complied with the Lending
Guidance.
20 Lending in compliance with the Lending Guidance must be done in the
correct order. If a dominant WTC position is above 90%, the position holder
must lend at level a sufficient number of lots to bring his position below 90%
before he may lend at a premium of ¼% of the cash price. Similarly, he must
lend at a premium of no more than ¼% of the cash price a sufficient number
of lots to bring his position below 80% before he may lend at a premium of
½% of the cash price. He must have reduced his position below 50% before
he may lend at a premium greater than those specified by the Lending
Guidance.
21 The LME provides three forums for trading: in the ring, on LME Select
and on the telephone. A dominant position holder should be prepared to
respond to requests for borrowing in all three forums. A dominant position
holder is not obliged to verify if the person borrowing from him is doing so to
cover a short. However, the purpose of the Lending Guidance is to address
the effect of his dominant position on those who are short. It would be an
abuse of the Lending Guidance for a dominant position holder to contrive to
ExD05203 9
lend to another person at the specified premium with the intention that that
other person could lend in the market at a higher premium.
Lending on LME Select
22 A bid on LME Select is a request to the market. A dominant position
holder must respond to bids on LME Select where those bids reach the
premium at which the dominant position holder must be prepared to lend. The
mechanisms for ensuring orderly trading on LME Select mean that a lower
offer entered into the system will trade with an existing higher bid. If there is a
bid in LME Select that is at a higher premium than that prescribed by the
Lending Guidance, a dominant position holder must trade with that bid to
identify the borrower and subsequently adjust the price back to the correct
premium. This adjustment cannot be done on LME Select but requires a
reversal trade and a new trade at the correct premium to be negotiated on the
telephone. If the circumstances suggest that bids for Tom/next borrowing on
LME Select will be higher that the backwardation premiums at which the
dominant position holder will be obliged to lend, the dominant position holder
should behave prudently and consider placing offers on LME Select to
anticipate bidding. This will avoid the need for adjustment trades.
23 If the dominant position holder is not a clearing member, he must make
arrangements with his broker to take the necessary steps to respond to bids
on LME Select and to make adjustments where necessary.
Lending in the Ring
24 A bid in the ring is also a request to the market. The first ring session
for each metal is the last opportunity to lend or borrow Tom/next by open
outcry. A dominant position holder who has not reduced his WTC position
below 50% by the start of the first ring must respond to bids in the ring where
those bids reach the premium at which the dominant position holder must be
prepared to lend.
25 The mechanisms for ensuring orderly trading in the ring mean that
once a bid to borrow has been made a lender must either accept that bid or
make a higher offer. It is a breach of the ring trading regulations to make an
offer that is lower than a prevailing bid. If a dominant position holder’s WTC
position remains at 50% or above by the start of the first ring, he must ensure
that he responds to bids and that any lending he does is at premiums no
higher than the premium prescribed by the Lending Guidance. In order to
ensure this and to abide by the ring trading regulations, it may be necessary
for the dominant position holder to offer to lend. If the circumstances suggest
that Tom/next trading in the ring is likely to start at higher premiums, the
dominant position holder should be prepared to open the ring with an offer
before any bid is made.
26 If the dominant position holder in these circumstances is not a ring
dealing member, he must make arrangements in good time for a ring dealing
member to effect the necessary lending on his behalf.
ExD05203 10
BROKERS INSTRUCTED BY DOMINANT CLIENTS
27 There are a number of considerations that a member must take into
account when acting for a client who is dominant. In particular, the member
must ensure that his actions comply with the FSA Code of Market Conduct
and the FSA Conduct of Business Rules.
28 If a member is instructed by a client to lend a number of lots at a
particular backwardation premium, that instruction is an order for the purposes
of FSA rules. In executing that order, the member must manage any conflicts
of interest, must not misuse customer information or breach the FSA Code of
Market Conduct. For example, it is clearly wrong for a member who is acting
for a dominant position holder to borrow from that dominant position holder, or
to collude with someone else to borrow from that dominant position holder, at
the premium prescribed by the Lending Guidance with a view to lending in the
market at a higher premium. Nothing that the member does should frustrate
the dominant client’s willingness or ability to lend to bidders in the market.
29 A member who receives an order from a client to lend in accordance
with the Lending Guidance may already have orders from other clients to
borrow. In situations like that, the member must be careful to comply with the
FSA’s rules on order priority and fair allocation. In those circumstances the
member must also keep in mind the responsibility on a dominant position
holder to respond to bids on LME Select or in the ring. If he receives an order
from a client to lend in accordance with the Lending Guidance and already
has a bid on LME Select that represents a client wishing to borrow he should
cancel that bid on Select before crossing the borrowing client’s order with the
dominant client’s lending order.
30 When a member receives instructions from a client to lend in
accordance with the Lending Guidance, that member will be in possession of
privileged customer information. The member must be careful not to take
advantage of that information and should give priority to his own clients who
are short and to bids on LME Select or in the ring over his house shorts.
CONCLUSION
31 Those who would like any further clarification or explanation of the
Lending Guidance should contact the Market Surveillance department at the
Exchange.
ExD05203 11
Schedule 2
Amendments to
part 1, Definitions, and
part 3 Trading Regulations
of the
LME rules and regulations
Part 1, Definitions
“Lending Guidance” paragraph 13.24 of Market Aberrations: The
Way Forward, published by the Exchange in
October 1998, setting out the behaviour
required of the holders of dominant long
positions in the Exchange’s metal markets,
including any clarification or explanation of that
behaviour issued by the Exchange from time to
time;
Part 3, Trading Regulations
16. POSITION LIMITS FOR PLASTICS CONTRACTS AND LENDING
GUIDANCE FOR METALS
16.1 [no change]
16.2 [no change]
16.3 Members shall comply with the Lending Guidance and shall co-operate
with the Exchange to ensure that each of their Clients shall comply with
the Lending Guidance.
16.4 Where the Exchange has reasonable cause to suspect that a Client
has failed or is likely to fail to comply with the Lending Guidance, the
Exchange may give directions to one or more Members with whom that
Client has Client Contracts to take action designed to make the same
number of lots available for borrowing in the market as would have
been the case if the Client were prepared to abide by the Lending
Guidance. Such directions to a Member may include but are not
limited to:-
(a) lending or offering to lend, at no more than a level premium, the
number of Exchange Contract positions equal to or less than the
Client’s long position holding of 90% or more as calculated by
the Exchange in accordance with the Lending Guidance; and/or
ExD05203 12
(b) lending or offering to lend, at no more than a premium of 0.50%
of the previous day’s Cash price, the number of Exchange
Contract positions equal to or less than the Client’s long position
holding of 80% or more but less than 90% as calculated by the
Exchange in accordance with the Lending Guidance; and/or
(c) lending or offering to lend, at no more than a premium of 0.25%
of the previous day’s Cash price, the number of Exchange
Contract positions equal to or less than the Client’s long position
holding of 50% or more but less than 80% as calculated by the
Exchange in accordance with the Lending Guidance; and/or
(b) trading out of sufficient Client Contract positions with that Client
to reduce that Member’s (or, if two or more Members are
directed, those Members') net exposure to that Client in line with
the action taken in compliance with the directions under (a) to (c)
above.
16.5 Compliance with the Lending Guidance is subject to the power of the
Special Committee to take steps or give directions under Regulations
15.1 to 15.3 above. Without prejudice to the generality of Regulations
15.1 to 15.3 above, such steps or directions may include suspending,
amending or supplementing the Lending Guidance for such period or in
respect of such metals as the Special Committee in its absolute
discretion deems necessary.