Charles Li Direct 
20/07/2016 
 

Charles Li Direct

Brexit and HKEX’s commodities strategy for China


There has been a lot of coverage of “Brexit” since citizens of the UK narrowly voted to leave the European Union. The fallout from the decision still remains to be seen, but many are asking me if it will have an impact on the London Metal Exchange and implementation of our commodities strategy. I’m happy to say our plans are on track, but I’d like to take a closer look at our growth plans, particularly pertaining to the Mainland.

BREXIT

Will Brexit have any impact on the LME?

Many people are still in shock about voters’ decision to leave the European Union, with analysts and pundits speculating on what impact the decision might have on global markets and the future of London as a financial centre. We are confident the impact on the LME will be limited, because trading on the LME is global and not confined to the UK or even Europe. Members and customers are from around the world, with future growth concentrated in Asia. Furthermore, LME trading is basically done entirely in US dollars, with operating income primarily in US dollars as well. Only operating expenses are denominated in pounds.

Finally, LME has been operating for almost 140 years, long before a European Union existed, and has thrived through all kinds of change and adversity. It is the world’s premier metals market and has proven to be strong, robust, and resilient.

Will Brexit affect plans for a “London-Hong Kong Connect” in commodities or other initiatives?

London-Hong Kong Connect was designed to clear and settle LME trades in Hong Kong, and was subject to Hong Kong, UK and European regulatory authority. With Britain withdrawing from the EU, there is some uncertainty about the policy developments in the UK. Therefore, we will wait and monitor the development of the UK and Europe’s regulatory policy before making further plans to connect the commodities markets in London and Hong Kong.

However, we don’t expect Brexit to have an impact on any other initiatives, such as establishing LME-certified warehouses in the Mainland. We are also still on track to launch our trading platform in Qianhai, Shenzhen to “physicalise” the Mainland’s commodities market.

PHYSICAL DELIVERY

Why does the LME want to set up warehouses in China, and how can they serve the country’s real economy?

Warehouses are important because when buyers can receive physical delivery, the futures and spot prices of any given metals contract will converge at the contract expiration date. The LME doesn’t own or operate any warehouses, but has a network of more than 600 certified warehouses in 35 locations. That means physical delivery is convenient and efficient, and futures prices truly reflect the real economy and global base metals supply and demand.

China is already the world’s largest consumer of raw materials, and many of the country’s metals users need to manage risk via LME futures contracts. Chinese traders account for more than 30 per cent of total LME trading, but because there are no certified warehouses in the Mainland, customers must make or receive delivery at a warehouse located elsewhere. That means the metal will then be shipped to or from overseas, with the trades stuck with high shipping costs and lengthy delivery times. This is a barrier to China participating in the global metals market.

Having LME-certified warehouses in the Mainland would not only reduce the cost of delivery for Mainland companies and give them greater access to LME trading and pricing, it would also help China gain influence in international commodities pricing over the long term that is commensurate with its size.

Finally, we are making good progress with LMEshield, our secure way to manage warehouse receipts. We recently announced we will list warehouses for the LMEshield repository in countries along China’s “Belt and Road” routes.

PRICING

China’s influence on pricing is weak, despite the fact it’s the world’s largest consumer of raw materials. How can this be resolved?

As things stand today, Chinese enterprises aren’t completely free to participate in international futures markets to hedge transactions because of foreign exchange restrictions, which means they can’t influence prices in overseas markets. At the same time, foreign exchanges and bonded warehouses are restricted in the Mainland, artificially increasing delivery costs for Chinese companies and resulting in them buying or selling at global prices without the ability to protect themselves via physical delivery or hedging.

On the other hand, trading is active on Chinese domestic exchanges but international users don’t participate in the Mainland price discovery process, so they naturally won’t accept prices discovered there because they have no influence. As a result, both international and Mainland users end up using overseas market pricing.

The key is creating a place where Chinese and overseas buyers and sellers can transact. It doesn’t matter where that platform is, as long as Chinese enterprises are able to contribute and it is trusted by both Chinese and international market participants.

What can be done to improve China's pricing influence in the commodities sector?

One option is for China to speed up the opening of its commodity futures market and welcome foreign investors to participate. If this isn’t feasible because of capital controls and other restrictions, it might make sense in the interim to allow Mainland enterprises and investors to go out and participate in international commodities markets.

QIANHAI TRADING PLATFORM

There are thousands of Mainland commodity spot trading platforms; why is HKEX launching its own in Shenzhen?

The Mainland has more than 1,000 commodity trading platforms, but most lack credibility, supervision, or a strong regulatory structure, with others exploiting regulatory rules by promising high-yield, low-risk products. We hope to build a standardised, transparent, credible spot commodities trading platform in Shenzhen for physical delivery that will serve China’s real economy.

We are confident because we have three major advantages: first, HKEX has a long track record as a trusted partner to the Mainland.  After the acquisition of LME, we were able to combine this with expertise and brand recognition in the commodities space. Second, we have the power, determination and resources to provide reliable warehousing, logistics and other facilities to serve the real economy effectively. Finally, we have the credibility of HKEX. We believe we can create a new price benchmark and use it to develop indices, futures, and other derivatives products in Hong Kong.

What challenges do you expect to face?

Our biggest challenge is not from Mainland regulatory policy, which is designed to protect investors and build a robust market in China, but from finding a way to adapt and customise global practices to the Chinese market. We believe in the merits of our objectives, which are highly consistent with China’s regulatory prerogatives. Although LME has a long track record in global commodities markets, the Chinese market is unique and we can’t expect to copy the international model and paste it in China. We will need to consider the local conditions and develop a commodities platform that serves the particular needs and characteristics of the Mainland market.


 

Share your thoughts on Charles Li Direct with us.  Email: ceo@hkex.com.hk.  All emails sent to this address will be read, however, due to time constraints, the chief executive will be unable to respond personally to every email.  If you have general enquiries or comments about HKEX, its products or services, please contact us through one of our usual channels.  Thank you.

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