Top bank stakeholders of the London Metal Exchange are likely to amass enough support to block a sale they fear would bring a more heavily regulated owner and hurt their lucrative warehousing businesses, senior industry sources say.
The LME said in September that at least 10 parties had expressed interest in buying it, and analysts estimate it could be worth as much as $1 billion (638.86 million pounds). As a member-owned organisation, the exchange requires approval from members holding 75 percent of outstanding ordinary or A shares for any sale.
Potential buyers are likely to include CME Group Inc, IntercontinentalExchange and SGX Singapore Exchange. The first two in particular have stricter U.S. regulators, which could threaten members' businesses.
Big banks such as J.P. Morgan, Goldman Sachs and Barclays Capital have invested heavily in physical metals business since the economic downturn began by buying warehouses and beefing up their trading teams and financing operations.
Shunting metal around has been a money spinner for them as slowing global growth pulls down commodity prices and leads to stockpiles of surplus material.
For the banks, simply storing all the metal can generate tens of millions of dollars in rental revenues.
LME rules allow warehouses to release only a fraction of their inventories per day, much less than the metal that is regularly taken in for storage. This creates long queues to get metal out and guarantees rental income.
Knowledge of trade flows -- which regions are buying or selling -- and the option to play price differentials between physical and paper markets provide these banks with an added avenue of profit.
Also, LME rules allow large companies to build up big positions in the futures market, which can impact metals prices. Stricter regulation could curb this.
So the banks could have an interest in scuppering a sale of the 130-year-old exchange, one of the last bastions of open outcry trade.
BLOCKING NOT SO DIFFICULT
Senior metals industry sources say a blocking stake of 25.1 percent would not be too difficult to build.
Between them JP Morgan and Goldman Sachs hold just under 20 percent of ordinary shares, and traditional metals trading firms could come to their support.
Anything that fundamentally altered the business model would not be acceptable, said the head of a ring dealing LME member, also a big shareholder.
I've heard a number of people say, 'It doesn't matter what the price is, it's my business model that's the issue'.
JP Morgan, Barclays and Goldman Sachs declined to comment.
The banks are deleveraging and are looking at opportunities where the regulator is not as tough as with a lot of the banks' activities, said veteran metals analyst Robin Bhar of Credit Agricole.
They've put a lot of investment in the warehousing systems. They see this as a long-term play, so I'm sure that's a factor that will come into play depending on the nationality of the bidder, he said.
The Federal Reserve and the European Commission are cracking down on risk-taking by large banks, and commodities are also coming under fire as regulators try to make the financial system more resilient to withstand future crises.
In October, the United States pushed through its toughest measures yet to curtail speculation in commodity markets.
The Commodity Futures Trading Commission voted 3-2 to approve position limits that will cap the number of futures and swaps contracts that any single trader can hold.
In Britain, the watchdog Financial Services Authority (FSA) so far has been seen as a soft touch, leaving the LME to regulate itself.
JP Morgan dramatically boosted its influence in the battle to acquire the LME by increasing its stake to become the biggest shareholder when it bought defunct broker MF Global Holding's 4.7 percent share, pushing Goldman to the No.2 spot.
They now have 10 percent plus of the company. For every 10 percent of their 'no' votes, it has to be 30 percent 'yes' votes, said the head of a brokerage that is also a large shareholder.
If the company (LME) goes for 75 pounds per share, they (the banks) make a very tidy profit. But if it doesn't because they believe their business model is tantamount to preserving the existing model, then they've got that too. Either way it's a no-lose scenario.
Bhar said: The two biggest shareholders effectively do have a strong say in whether the bid is accepted or not.
ONE-OFF PROFIT VS HIGHER COSTS
The LME makes little profit but keeps fees low for its members who also own the business.
The 12 LME members allowed to trade in the LME's open outcry ring could be hit by an increase in running costs if a new owner decides to boost profits at the exchange by hiking fees at a time when margins are being crimped by a global economic slowdown and a move to more electronic trade.
In that case, members would have to weigh whether a one-off profit from selling their stakes at a sharp premium compensates for higher costs in the longer term.
I would be one of those who would say I'm not going to be unduly impressed by how big the size of the cheque is, said the of the head of the metals brokerage, which is also a big shareholder.
That could play into the hands of the banks, who have suffered losses in the economic downturn and would be keen to keep their lucrative warehousing businesses intact.
If you think there is a high chance of a sharp slowdown, even recession, warehouses come into their own because more metal gets stockpiled, gets financed. They make the money on the financing and earn money on the rent, Bhar said.
In a typical financing deal, a bank buys metal from a producer, agrees to sell it at some future point at a profit, and strikes a warehouse deal to store it cheaply for an extended time period.
And rent just got costlier.
The LME on Friday published new maximum rents, set by warehouse operators. Storage of copper in LME-monitored sheds will rise by more than 10 percent and aluminium by 9 percent. That compares with a roughly 1 percent rise last year.
But it could be difficult for the banks to persuade other veteran brokers to hold onto their stakes. Some say a sale makes sense and that even if the first round of bids fizzles, the LME may yet have to yield to a suitor further down the road.
Personally, I think it should be sold, said a managing director of a ring-dealing member. The consolidation of exchanges and clearing houses is inevitable, so why not try to work out a good deal and also benefit from a lump sum payment.
The exchange is steeped in tradition. A descendant of one of its founders still deals on its floor. Some sources say the LME must change with the times or risk becoming defunct.
The LME has to change its business model or it will become extinct, said the chief of another LME member.
(Additional reporting by Eric Onstad; editing by Jane Baird)