COLUMN-LME swats a warehousing fly, but what about the tigers? Andy Home

(Repeats May 1 item. The opinions expressed here are those of the author, a columnist for Reuters.)

By Andy Home

LONDON, May 1 (Reuters) - The London Metal Exchange (LME) has fined one of its warehousing operators, CWT Commodities (Metals), 100,000 pounds ($149,000) for breaching information barriers with associated trading companies.

At a time when multi-million-dollar penalties are regularly being levied against the banking sector for a litany of past bad behaviour, 100,000 pounds may sound like peanuts.

But it's actually the second-highest fine imposed by the LME on any of its warehousing companies.

The dubious distinction of highest-ever fine goes to Albatros, which got hit with a 200,000-pound charge in the late 1990s for storing tin that didn't meet contract specifications.

The result was the forced cancellation of 1,000 tonnes of metal with what the LME termed "substantial disruption in the market" and a protracted court battle between the LME and Albatros.

The only directly comparable disciplinary action to that against CWT was the 50,000-pound fine imposed on Henry Bath in 1999 for trading metal on its own account.

CWT does not appear to have been guilty of such a flagrant disregard for LME rules but can't be surprised it has been hit so hard given the current regulatory scrutiny of all things related to LME warehousing.

And information barriers cut to the heart of one of the most contentious areas of LME storage, namely the ownership of many warehousing operators by trading companies.

CONFUSION, NOT CONSPIRACY

Actually, CWT isn't owned by a metals trading company.

Rather, it owns one in the form of MRI Group, a specialist raw materials trader that absorbed another group trading entity, LN Metals, a year or so ago.

And at least two others, it seems, since the accusation is that CWT "failed to identify two companies within its corporate group which were Trading Companies (...) despite repeated requests from the LME to do so".

From that failure flows a long list of charges dating to 2012 about persistently not complying with the LME's information barrier rules, intended to prevent trading companies benefitting unfairly from their relationship with warehouse operators.

But this is hardly the stuff of grand conspiracy.

After all, the LME conceded that it had found no evidence that CWT deliberately broke the rules, that any sensitive information had actually been exchanged or that any third party was affected.

CWT's real offence seems to have been failing to ask its parent for a proper organisational chart, given "its own policies and procedures failed to identify the fact that the two entities were trading companies" as defined by the LME rulebook.

Perhaps that's understandable given the complexity of the CWT group, with 6,000 employees engaged in all aspects of the logistics business from wine storage to defence contracts as well as in financial services and asset management.

Ignorance is, however, no defence, least of all when the LME has the UK regulator, the Financial Conduct Authority, breathing down its neck after a string of allegations about the impact of its warehousing system on the aluminium market.

Moreover, LME rules place the onus on complying with its information rules on the warehouse operators rather than any related non-member trading entities, over which it has by definition no jurisdiction.

In other words, if CWT didn't know, it should have known and it, not the parent group or those two mysterious trading entities, must bear the consequences.

FLIES AND TIGERS

That said, there is a sense that the LME has swatted a fly with its action against CWT, to borrow the language used by the Chinese leadership in its anti-corruption drive.

CWT is certainly no LME warehousing tiger.

Its sheds held 44,857 tonnes of registered metal at the end of March, accounting for just 0.81 percent of LME stocks.

It is one of several minnows operating in a sector dominated by four tigers. Between them Pacorini, Steinweg, Metro (Other OTC: MTRAF - news) and Henry Bath held over 95 percent of registered LME tonnage at the end of March.

Pacorini is the dominant tiger, storing more than half of all exchange-registered stocks in its system. This is not entirely surprising given it is owned by Glencore (Xetra: A1JAGV - news) , the powerhouse of physical metals trading.

Henry Bath is now owned by trading house Mercuria, having been sold by JPMorgan (LSE: JPIU.L - news) .

Metro was owned by Goldman Sachs (NYSE: GS-PB - news) , a relationship that provoked much of the original outcry over LME warehousing. It is now owned by the Reuben brothers, who have a long history of active metals trading.

Steinweg is the only independent, a statement that holds truer since the apparent cutting of ties, always obscure, with Asian metals trader Raffemet.

There's been no suggestion of impropriety against such tigers but linear hierarchical links between trading and LME logistics are by their nature problematic.

Particularly when two of those operators, Pacorini and Metro, are the owners of two long load-out queues at Vlissingen and Detroit respectively.

NEED TO KNOW

Consider, for example, a U.S. Senate subcommittee's findings on the relationship between Goldman and Metro, as part of a broader hearing on Wall Street banks' involvement with physical commodities.

Goldman, unlike CWT, ticked all the LME's compliance boxes, submitting as required an annual independent auditor's report on the strength of its information barriers.

However, the subcommittee still found that "all told, nearly 50 Goldman employees, including Commodities executives and traders, have had access to confidential Metro information, including information that could be commercially valuable to a trading company".

These included "individuals working in the bank's Market Risk Management & Analysis, tax, litigation, accounting, audit, compliance, derivatives, and commodities departments".

Most acutely, they included executives occupying senior positions in the bank's organisation with oversight of Metro as well as commodities trading.

Isabelle Ealet, for example, was co-head of Goldman's Securities Division, and received monthly updates on Metro's pipeline of storage deals.

"Ms. Ealet told the Subcommittee that while she was not typically involved in the day-to-day management of trading, she may become involved in specific trades or issues from time to time."

In its defence, Goldman argued that any such information had been sanitised precisely to minimise potential conflicts of interest.

But the subcommittee also identified a key weakness in the LME's information barrier policy, namely that the audits "were limited to reviewing Metro's information barriers, since the LME requirement applies only to warehouse companies and not to their affiliated trading companies".

The auditor, PricewaterhouseCoopers, "did not undertake a similar review of Goldman".

ONE CHEER FOR COMPLIANCE

In an ideal world, it would be against the LME rules for any big trading company to own a logistics company involved in storing exchange metal.

But it's not an ideal world and the precedent for trading-warehousing tie-ups was set long ago.

Not when the LME allowed one of its brokers, MG, to buy Henry Bath in the early 1990s.

It happened as far back as 1883, when Henry Bath issued the first LME warrant. At the time the company was not only one of the founding members of the exchange but also a storage and logistics company, an operator of copper smelters in Wales and a major physical trading house. Think a 19th century version of Glencore.

The conflict of interest between trading and storage is hard-wired into the exchange's history and is not going to go away.

The LME is tasked with managing that inherent conflict of interest and its treatment of CWT shows it will take no prisoners in applying its rules.

But throwing the rulebook at CWT will not assuage the general unease about so much of the LME's stocks being controlled by tigers, both warehousing and trading ones. (Editing by Dale Hudson)