HKEx faces battle to make most of planned LME buy
Hong Kong's government has long wanted to turn the city into a leading centre for commodity trading.
Now, with the news this week that Hong Kong Exchanges and Clearing - in which the government is the largest shareholder - is one of the two remaining exchanges still bidding to acquire the London Metal Exchange, the administration is a step nearer to realising its ambition.
But HKEx's purchase of the LME is not yet a done deal. And even if the deal does go through, the operator of Hong Kong's stock exchange may find that extracting value from its takeover is a tougher proposition than it expects.
In the age of electronic trading and over-the-counter deals, one prominent analyst has dismissed mergers between traditional exchanges as 'just dinosaurs mating'.
In that case, the LME looks like an anachronism even among dinosaurs. Unlike other leading exchanges, which demutualised a decade ago or more, the LME is still owned by its brokers.
And they can be an - ahem - colourful bunch. Although the exchange now boasts an electronic trading platform, price discovery still takes place primarily on the trading floor.
But instead of the open-outcry pits crammed with gesticulating and shouting traders familiar from Chicago's commodity exchanges, on the LME brokers sit in a circle called the ring to strike their deals in five-minute bursts of trading.
It looks relatively gentlemanly, but such looks can be deceiving. Unkind critics say the LME's traders need to sit down during the afternoon ring session to disguise the length and liquidity of their lunches.
One retired Asian trader describes his former LME colleagues as 'horrible, horrible people; the worst I have ever met'.
Some clients agree. During the 1990s, Japanese trading giant Sumitomo, the Chilean state copper company and China's Citic all suffered heavy losses after finding themselves on the wrong side of LME trades.
Clearly its distinctive culture will make the LME a challenging acquisition for HKEx, a newcomer to the international takeover game. And the challenge will be all the greater, given that HKEx's rival, the Atlanta-based Intercontinental Exchange, has already successfully absorbed another London commodity futures market, the International Petroleum Exchange.
Even so, the LME could prove a rich prize for HKEx, while the Hong Kong exchange operator has the potential to offer significant value to the LME's membership.
Despite its quirks, the LME dominates the world's trading in industrial metals, especially copper and aluminium, thanks largely to its worldwide network of warehouses where customers can deliver and receive the physical metals they trade.
But there is a hole in that network. Because of the mainland authorities' suspicion of foreign exchanges, the LME has no warehouses in China. As a result, although China now consumes 40 per cent of global copper supplies, Chinese clients account for only around 25 per cent of copper trading on the LME.
HKEx hopes to persuade the LME's voting members that if they choose its bid over the ICE's, the Hong Kong exchange will be able to use its contacts with regulators in Beijing to secure permission to open one or more metals warehouses on the mainland, significantly boosting trading volumes from Chinese customers.
The promise of more business from China may well swing the LME's membership behind HKEx's bid, even though the ICE is reported to have offered a higher price for the London exchange.
Yet delivering on that promise could prove difficult. It is not clear that mainland regulators will favour a Hong Kong-owned exchange over a US-owned market, especially after the Hong Kong Mercantile Exchange failed to secure mainland delivery for its proposed contracts.
And even under HKEx ownership, the LME's expansion into China will face stiff opposition from the mainland's home-grown metals market, the Shanghai Futures Exchange. Although the Shanghai exchange is the world's largest metals market by contract volume, an estimated 90 per cent of its turnover consists of speculative dealing by local day-traders.
That means the market is of little use to Chinese metals users, who want to hedge prices over periods of months. Even so, the mainland exchange will hardly be likely to welcome foreign competition on its home turf.
Despite the difficulties, however, China's continuing investment in metal-intensive sectors like its power grid, construction and clean energy mean the mainland's demand for industrial metals like copper is only going to rise over the coming years. As a result, from the point of view of a cash-rich HKEx and its Hong Kong government shareholder, the LME is a prize well worth bidding for.