(Kitco News) – One week after catching wind of the scheme, the London Metal Exchange (LME) has announced new plans to close loopholes that allow traders and warehouse operators to game the latest series of sanctions on Russian metals.
As reported last week, with the ink on the new sanctions barely dry, UK traders immediately began making deals with LME-approved warehouses to profit off the massive stocks of Russian metal that were already in storage and sanction-free (type 1 under the rules) by ‘withdrawing’ them on paper, then resubmitting them as sanctioned (type 2) metals, whereupon they made deals with the warehouses to split the profits on the indefinite rent these now-untradeable metals would accrue.
Bloomberg reporters called it “the latest episode in a rich history of traders seeking to exploit loopholes to profit from giant stocks of aluminum on the LME, which can generate hundreds of millions of dollars a year in storage and handling fees.”
At the time, the LME responded to news of the scheme in a statement, saying that the exchange “continues to monitor the market closely and remains ready to take further action should that be required, including in relation to adverse market behaviours as a result of the introduction of the recent sanctions.”
“The UK and U.S. governments were hoping that by allowing older Russian metal to continue trading, they would avoid a drain on stocks and any resulting price turbulence,” wrote Reuters columnist Andy Home. “They didn’t allow for the fact that after years of gaming the LME’s labyrinthine rules around load-out queues, both aluminium traders and warehouse operators are primed to spot any regulatory gap, however narrow.”
Now, the LME has updated its regulations in an attempt to close the loopholes that make the scheme legal and profitable.
“Following the implementation of the new measures in response to the Amended Sanctions Package, the LME has undertaken engagement with market participants, with the aim of ensuring that the measures implemented to comply with the UK sanctions regime continue to be as efficient and effective as possible,” they wrote in a statement. “Accordingly, the LME considers it appropriate to make some refinements to its approach.”
“When a Type 1 Russian Warrant is re-issued, the owner has the option to convert it to a Type 2 Russian Warrant,” they said. “However, this does not change the fact that […] the warrant may still be cancelled and loaded-out by UK Persons (because it was on warrant as at the end of 12 April 2024). As such, the LME is introducing the ability for Type 1 Russian Warrants which have subsequently been converted to Type 2 Russian Warrants to be re-converted to Type 1 Russian Warrants.”
This makes the ‘unsellable’ stocks created on paper through the scheme become sellable again, eliminating the indefinite rent money they would accrue.
In another section, the LME tersely addressed the misuse of the profit-splitting rent agreements themselves.
“The LME understands that, in respect of Russian Warrants, metal owners may wish to enter into PostSale Economic Incentive Arrangements (“PSEIAs”, as defined in the LME Warehouse Agreement, of which rent share agreements are a sub-category),” they wrote. “All market participants are reminded of the general Warehouse Agreement and Rulebook requirements in respect of rent, and in particular, the use of PSEIAs [..] which states that ‘no Warehouse shall agree any Post-Sale Economic Incentive Arrangement in respect of any Warrants and/or Underlying Metal, the terms or effect of which is to prevent a Later Metal Owner from withdrawing from the Warehouse the Underlying Metal and/or making alternative arrangements for the storage of such Underlying Metal.’”
“Given that the conversion of Type 1 Russian Warrants to Type 2 Russian Warrants could have the effect of reducing the ability of UK Persons to withdraw underlying metal from the warehouse (and would not appear to have any obvious benefits),” the LME will consider those agreements to be in violation of the terms of the Warehouse Agreement, they said.
Barring further ingenuity by LME traders, the updated rules should eliminate the scheme and allow the type 1 metals stocks already in approved warehouses to act as a supply buffer for the Western markets, as intended.
Still, even if they are enforced to the letter, the sanctions may not succeed in starving the Russian war effort. According to a recent report from ING, the end result of the new sanctions regime will be an even greater share of Russian metal flowing to sanction-neutral countries, at ever-lower prices.
“The LME is a market of last resort for the physical metals industry,” the ING report noted. “Although most metals traded globally are never delivered to an LME warehouse, some contracts stipulate that the metal should be LME deliverable. This means that Russian companies will be forced to accept lower prices. Russia-origin metals will trade at even wider discounts and continue to flow to sanction-neutral countries, like China, the world’s biggest aluminium consumer.”
The bank said that China “is likely to continue to buy discounted Russian material to use domestically” while exporting their own domestically-produced and unsanctioned aluminum to Europe and the U.S. to fill the supply gap, effectively buying low and selling high.
Disclaimer: The views expressed in this article are those of the author and may not reflect those of Kitco Metals Inc. The author has made every effort to ensure accuracy of information provided; however, neither Kitco Metals Inc. nor the author can guarantee such accuracy. This article is strictly for informational purposes only. It is not a solicitation to make any exchange in commodities, securities or other financial instruments. Kitco Metals Inc. and the author of this article do not accept culpability for losses and/ or damages arising from the use of this publication.