After so many high profile mergers fell through in 2011 and early 2012, the prospects for exchange mega-deals was bleak. But last month, Hong Kong Exchanges and Clearing succeeded in its bid to acquire the London Metal Exchange and there appears to be little resistance to the deal from the governing bodies on each side.
It’s hard to deny that the LME got a pretty sweet deal from HKEx. The fact that the CME, NYSE and the IntercontinentalExchange all made bids for the exchange put the LME in a real position of power and allowed it to dictate some key terms.
However, the deal was not just about the price, although coming in at a whopping £1.388 (a lucky number for the Chinese exchange) it was obviously a factor. The preservation of the open-outcry model was reported to be a key factor in the deal.
As a result when LME announced the deal it was quick to stress that “HKEx has committed to preserve the LME brand, the operation of the Ring (including open outcry trading) and the prompt date structure of all contracts traded on the LME. Furthermore HKEx will not increase fees for contracts currently traded on the LME”.
Another benefit to the deal for the LME is that HKEx, which already operates three clearing houses, will be able to provide expertise and experience to the clearing house that the LME is planning to launch next year.
Most of the large Western exchanges are trying hard to break into the Chinese markets and by joining with HKEx, the LME has a great chance of access this market and with China currently accounting for around 42% of global metals consumption, this could prove to be a massive boost for it.
The business model will stay the same and it will still be regulated by the FSA in London, so really it’s just business as normal for the LME. Plus it will get help building out its clearing house, have an advantage over rival in access metal-hungry China and can leverage HKEx’s IT infrastructure for market data distribution in China. All this and the LME members are £1.388bn richer for it.
On the surface of the deal, it is questionable whether HKEx got such a good deal. It ended up paying 180 times the LME’s 2011 earnings.
Also, with this deal HKEx is setting itself up in direct competition with the Shanghai Futures Exchange (SHFE), which already lists base metals contracts that are deliverable in the domestic Chinese market and is looking to launch dollar-based products itself.
China’s derivatives markets are highly politicised, and while HKEx must have had the approval of one part of the Chinese government to make this deal, there is no telling how it will react to the competition between the two exchanges, especially considering that the SHFE has strong contacts with the government.
However, when analyzing HKEx’s side of the deal it is important to understand the long term strategy. The LME’s earnings were minimal because it is was run for its members rather than its users and was a not-for-profit exchange. After 2015, HKEx has licence to change this business model and when it does the profit from the LME should increase.
There is a reason, after all, why so many big exchanges all went in for the LME. In 2011 it achieved record volumes with 146.6m lots, equivalent to $15.4 trillion and $61bn on an average business day, with more than 95% of its business coming from outside the UK.
Over 80% of global non-ferrous futures business is transacted on its platform and the exchange is so dominant in metals trading that the price discovery that occurs at the LME sets global benchmarks for a number of metals.
Considering how important the LME is in price discovery for metals, that most of its business comes from abroad and that Asia where the biggest demand for commodities is coming from, the HKEx buying the LME definitely makes sense.
Diversification of its offering is another key part of the rationale behind the HKEx bid. Traditionally home to equity derivatives, the exchange this month announced the launch of RMB currency futures and commodities marks a natural area of expansion.
Asia is a commodity-hungry region and its markets are starting to mature, with the result that firms are looking beyond equities towards more sophisticated risk management tools like derivatives. So while this move has proved costly in the short-term, there is certainly money to be made by owning the LME in the long-term as HKEx will push to become the commodity trading hub of Asia and its plans to build warehouses in China will strengthen its hand in the largest market in the region.
It has to be conceded that for most firms purchasing the LME for £1.38bn would be considered a bad piece of business. But the HKEx clearly has enough resources that it can buy the LME as part of a long-term strategy and over time it may well prove that what it paid for the metals exchange is not as important as the fact that it owns it.