End of the beginning in long LME journey
After a more than 10-month battle, Hong Kong Exchanges and Clearing (HKEx) finally won approval last week from the shareholders of the London Metal Exchange (LME) for its GBP1.39 billion (HK$16.78 billion) takeover.
While the voting result marked the first overseas acquisition by the local bourse, it also marked the beginning of a marathon journey for the HKEx to turn the LME from a non-profit-making entity into a profit-driving engine.
Analysts believe the HKEx will need to recruit new talent, raise trading fees and introduce yuan products to make its newly acquired operation profitable.
The deal is pending approval from the British Financial Services Authority but analysts believe there will be no great difficulties in getting the regulatory green light. The bigger problem for the stock exchange will be getting a return on its investment.
'The HKEx will keep all the management of the LME but will also have to hire additional staff who know about commodities trading,' First China Securities chief executive Kenny Lee Yiu-sun said.
'The current management of the HKEx, from chief executive Charles Li Xiaojia to the other levels focus on stock trading and new listings. It has to establish a new team to handle the commodities trading or the LME will also out of its control.'
The LME is owned by 70 shareholders, mainly investment banks and metal traders. It had previously attracted offers from rivals, including CME Group, IntercontinentalExchange (ICE) and NYSE Euronext but was lost out to HKEx, which offered the highest price.
But some brokers in Hong Kong have queried the price tag, which represents 180 times the LME's profit last year. To finance the deal, HKEx said in June it would take out GBP1.1 billion in bank loans which would be repaid through shares and bond issuance. The LME takeover is part of Li's plan to diversify the exchange business away from relying too much on equities.
The LME, the world's largest metal exchange, handles more than 80 per cent of the world's trade in industrial-metal futures, setting global prices for metals from copper to aluminium to nickel. It still uses so-called open outcry, in which traders use hand gestures and call out prices. It handled a record US$15.4 trillion worth of contracts last year. The HKEx has promised to keep the existing trading method in London until at least 2015.
Commodities trader James Rogers said HKEX would eventually need to modernise the LME.
'The LME should be modernised to use electronic trading if HKEx wants to turn it into a profitable business,' Rogers said.
A Credit Suisse research report said the LME deal would help diversify the exchange's business and represent about 10 per cent of its future revenue.
'However, nearer term this deal is dilutive to earnings given the high multiple paid and additional cost incurred in developing the Asian platform ahead of additional revenue generated,' the Credit Suisse report said.
Credit Suisse said HKEx would need to help the LME with its IT system and to establish its own clearing house. That replaces the present practice that now sees all contracts traded through the LME cleared through an external clearing house. It would also need to expand the LME's footprint in Asia, launch yuan products and offer other types of commodities, Credit Suisse said.
The LME has historically run a 'profit constrained' model whereby fees were kept low for the benefit of its members. Following consultations with its members, LME increased fees by 40 per cent from July 2, while HKEx will not be able to increase fees further until 1 January 2015. Brokers believe more fee rises may be needed after that.
Kelvin Wong Tin-yau, chairman of the Hong Kong Institute of Directors, said HKEx had an excellent record in expanding trading platforms of its securities in Hong Kong.
'A smooth transition after the acquisition is as important as the cultural fit between HKEx and the LME. At the end of the day, it should be HKEx who should take the lead in defining the longer-term strategic direction of the LME, not the reverse,' Wong said.
'Hong Kong and London have a perfect complementary advantage in terms of trading hours. Hence, it only makes sense to expand the LME's trading platform by further enhancing its efficiency and capacity.'
Joseph Tong Tang, executive director of Sun Hung Kai Financial, does not think the HKEx takeover of the LME would substantially change the commodities market worldwide. 'Rather I would expect quite a lot of changes to the LME going forward since it is used to running as a non-profit-making institution,' Tong said. 'Reorganisation and how successful the results will be is one of the biggest challenges facing HKEx.'
HKEx plans to take this amount in bank loans to finance the London Metal Exchange deal