(Bloomberg) — In 2002, the metals industry was thrown into turmoil after a U.S. warehouse owner announced it would charge a fee to securely secure any cargo moved from its depots into the London Metal Exchange’s storage network.
Most read from Bloomberg
Overnight, traders trying to access metal to back the LME futures contracts were hit with tens of thousands of dollars in additional fees for work that took a matter of minutes. If someone refused to pay, the metal was left behind, meaning the warehouse could continue to charge rent. After furious complaints, Metro International Trade Services was reprimanded by the LME for charging fees to discourage withdrawals from its warehouses.
Ten years later, Metro was catapulted into the public consciousness at the center of a much larger firestorm – accused of orchestrating aluminum supply backlogs that roiled the LME and lasted more than two years at their peak as rivals followed suit . Metro executives and then-owner Goldman Sachs Group Inc. were among those dragged before a U.S. Senate investigation and accused of predatory behavior that distorted commodity prices for everyone from automakers to beer companies.
As the metals world converges on London for its annual LME Week meeting, the industry is once again fighting over a controversial storage fee. And at the heart of the latest controversy lie some of the same people.
It’s a story that highlights how a small handful of largely private warehouse companies play a crucial role in the LME – and how one group of warehouse operators in particular have spent decades finding ways to push the exchange’s rules to their limits to maximize their own rules. gain.
They now work at Istim Metals LLC (named after Metro’s initials, backwards) and have introduced a charge that some say is contributing to a squeeze on the aluminum market that threatens to come to a head in the next two weeks. The situation has attracted global players including Citigroup Inc. and Squarepoint Capital LLP, and the LME handles complaints about unfair practices by some members. At least one party has filed a complaint with the British financial regulator.
Metro itself has new owners and managers and has a much lower profile these days. Michael Whelan, whose father William founded Metro, now runs Istim. While Metro once dominated LME’s storage, today Istim is so important to the LME ecosystem that it stores about half of the metal in the exchange’s global network.
Over more than two decades, the Whelan family has become crucial players in the metals markets, thanks in part to their knack for finding wiggle room in the LME system to attract metal to their sheds and keep them there. The tactics pioneered first by Metro and then by Istim shaped the way the market has developed, leaving rivals behind and forcing the LME to change the rules to keep up.
This story is based on interviews with more than two dozen current and former metals insiders, most of whom asked not to be identified discussing private transactions. Whelan and Istim are described in terms ranging from anger to admiration – and often both. Depending on who you talk to, they’re either the bad guys of the metal warehouse, or the creative geniuses of it.
“The sad truth is that everyone has learned to love it because they have realized that these market inefficiencies can be traded very profitably,” says a veteran metals trader who filed a complaint about Metro’s handling fees in 2002 but was contractually limited is until when he publicly discussed his work. “I shake my head, but ultimately what else would you expect from traders?”
Istim, Citigroup, Squarepoint and the LME all declined to comment for this story.
The network of privately owned warehouses licensed by the LME is designed to ensure that exchange prices do not diverge too far from conditions in real metal markets, serving as a backstop for consumers who need metal at short notice, or producers who want to offload it.
But despite its significance as a marketplace setting global benchmarks for aluminum, copper and nickel – the total notional value of contracts traded in a year is $15 trillion – the LME and its warehouse system regularly turn into a playground for traders.
Tensions have increased over the past year as oversupply in markets has pushed inventories higher and a deep discount between spot and futures prices in key markets creates opportunities to make profits by holding metal. The more metal traders have to use, the more effective their chess moves can be – and the more lucrative they become for rent-hungry warehouses.
In May, Trafigura Group dumped a huge stockpile of aluminum on the LME in Port Klang, Malaysia. The move roiled the market and was a huge windfall for Istim, but rival players including Squarepoint and Citigroup quickly lined up to withdraw stock, creating a queue of more than nine months in late August.
Queues are difficult for buyers if they need the metal urgently. But the LME rules also say anyone who waits longer than 80 days can stop paying rent, meaning extra-long arrears could actually be profitable.
If prices rose, traders assumed they would resupply their metal to the LME. That’s exactly what happened over the past few months, as a flurry of buying pushed prices for the October main contract to a premium the following month.
Istim increased the metal re-registration fee to $50 per ton, making the maneuver significantly more expensive. (The industry standard is $5 to $10. Although the LME limits the rent warehouses in its system can charge, there are no fees for re-registering metal.)
Critics have suggested that the levy is intended as a deterrent to the removal of stock from Istim sheds, and that it distorts prices on the LME by delaying re-registration. In its defense, people close to Istim say it is working within the rules to protect its profits in a low-margin business, and that it has told its customers that costs are negotiable. They claim it is the traders who are abusing the LME rules for free rent.
The company has since halved the fee after receiving an inquiry from the LME, but it is still around three times higher than the norm.
The clash has also raised questions about the potential for conflicts of interest between storage companies and their largest customers. It is common for warehouses to offer a large portion of their rent (often about half) to the merchant who originally supplied the metal, as long as it remains in the warehouse. This means that both parties benefit the longer the metal remains in place.
Long position
Trafigura is also a major player in the current aluminum market, having taken a large long position in the LME’s key monthly aluminum contract for delivery in mid-October, according to people familiar with the matter.
LME data shows a single long position with more than 30% of the main contract due for delivery mid-month. This means the company would have the right to pick up at least 550,000 tonnes of aluminum if contracts expire until the end of the month. That’s more than the amount currently available in the LME’s global storage system, and prices for those October contracts have continued to rise, putting further pressure on traders in the queue.
Trafigura declined to comment.
For the LME, these tricks are a constant source of headaches as it is forced to settle disputes and be on the lookout for any threats to the orderliness of its market. Yet the exchange’s executives are also well aware of the importance of the small handful of companies like Istim that can handle the mountains of metal flowing through the warehouse system.
At least one party has filed a complaint with Britain’s Financial Conduct Authority, according to people familiar with the matter. The FCA declined to comment.
Merry-go-round transactions
It is a constant effort for storage companies to attract stocks to their warehouses and keep them there for as long as possible.
When demand for aluminum plummeted after the global financial crisis, Metro entered into agreements with traders and manufacturers to store more than a million tons of unwanted metal in Detroit warehouses. Rental income started pouring in, and the windfall was so big that it caught the attention of Goldman Sachs, which bought Metro for $451 million in 2010. (Michael Whelan and Metro CEO Chris Wibbelman remained after the sale.)
But it was the plan to keep the metal where it was that put Metro and Goldman in the global spotlight. The company discovered a now infamous clause in the LME regulations: the minimum daily unload rate to meet metal withdrawals could also be read as a maximum.
The discovery, combined with incentives that encouraged “merry-go-round” trading – simply moving metal between sheds – created a queue for metal that quickly multiplied across the industry as other traders and warehouses followed suit.
“It affected not only the North American market, but the global market,” said Nick Madden, who was the world’s largest individual buyer of aluminum at the time as head of purchasing at Novelis Inc. “It was a stark reminder that whatever happens at the LME impacts everyone in the aluminum industry.”
In the wake of the fallout, Goldman sold Metro, which eventually agreed to pay $10 million to settle with the LME over the saga.
Michael Whelan, now 50, had resigned from Metro when the scandal reached boiling point. He founded the Pilgrimage Music Festival, which is also backed by Justin Timberlake, and has since also invested in a chain of taco stands and a boutique hotel, as well as a copper recycling plant in Spain.
By 2014, Whelan was back in the warehouse industry, running Istim. Ex-Metro CEO Wibbelman also still works closely with the family, but has become less active in the LME warehousing sector.
Back then, rent sharing was the hot play in warehousing. Istim quickly took action, using the incentives to strike deals for new mountains of metal.
Rent sharing is now widely adopted by warehouse companies across the industry and is a key factor in the calculations for merchants trying to monetize the warehousing system. It’s also a regular bugbear for the LME, which introduced rules in 2019 limiting how the incentives can be used. However, at times, such as during a meeting with Glencore Plc in 2019, the LME has also sided with Istim during disputes.
“The LME is always doing what they can to respond to the challenges, but it’s like squeezing a balloon: the air is going to move somewhere and another problem will appear,” said Madden, the former Novelis director. “Ultimately, they cannot change the mindset of the people involved in the market.
Most read from Bloomberg Businessweek
©2024 BloombergLP
