How It Works
Overview
Trading on the LME consists of open outcry trading, which takes place in ‘the ring’, as the trading arena is known, supported by a 24 hour telephone market and screen-based trading on LME Select.
All LME trades are captured by the LME Matching and Clearing System (MCS).
The Matching System matches purchases against sales during the business day, from details keyed in by Clearing Members or direct from LME Select. Matched trading data is presented for registration to the Clearing House, as prescribed in the LME Rules, in the name of the Clearing Member submitting them to the Matching System. Such presentation constitutes confirmation by the Clearing Member in whose name the contracts are presented. Trades that exceed pre-set price or lot size limits are suspended within the Matching System, pending confirmation of acceptance by the Clearing House.
The following functions are performed within the Clearing System:
- settlement;
- position maintenance;
- margin calculation;
- deliveries and option exercise allocation processing.
View the LME Systems User Guide
Novation
When LCH.Clearnet has accepted a contract for registration it is replaced, by novation, with two new, separate contracts involving LCH.Clearnet as both buyer and seller respectively. It is the latter contracts that remain on the register. As soon as novation occurs, the original contracting parties no longer have a contractual relationship with each other. Each now has a contract with LCH.Clearnet.
LCH’s obligations as central counterparty continue until final settlement as defined in the contractual terms of each contract. There are two types of settlement.
Cash settlement organised by LCH.Clearnet (most financial futures and options on futures)
Delivery versus payment organised by LCH.Clearnet (physical-deliverable commodity futures and options on futures)
Variation Margin
All open contracts are marked to market daily by LCH.Clearnet in accordance with the LME Rules. The official quotation is used as the market price. Profits or losses are either credited to or debited from Members’ financial accounts (realised margin) or they form non-realised contingent liabilities or credits.
Realised Margin
Realised margin is the calculated profit or loss arising from a comparison between the value of open positions at the relevant official quotations with the value of positions recorded in LME Clearing System - i.e. the trade price for new trades and the previous day’s official quotation for other positions. Variation margin for LME Index futures contracts (LMEX) and LMEminis is realised into postings to Clearing Members’ financial accounts:
Non-Realised Variation Margin
Non-realised variation margin is calculated with reference to the original trade price and the relevant official quotation. Non-realised variation margin is applicable to LME metal futures and plastics contracts.
Option Variation Margin
As premium is paid upfront, option variation margin is the value of unexpired options, calculated with reference to the official quotation. Bought and sold options generate credit and debit option variation margin respectively.
Calculation of Initial Margin
London SPAN
Initial margins are re-calculated at the close of each business day using the London SPAN algorithm, which is an adaptation of the SPAN method developed by the Chicago Mercantile Exchange.
Settlement
Cash Settlement
Cash settlement is a final settlement derived from the difference between the expiry price or final settlement price and the previous business day’s official quotation. This is debited from or credited to Clearing Members’ financial accounts and applies to
LME Index futures contracts (LMEX) and LMEminis. There is no physical delivery of open positions.
Delivery
LME metal and plastics futures contracts remaining open at expiry are settled by physical delivery of the underlying at the official settlement price as determined LME. Deliveries are made via SWORD.
Option Exercise and Expiry
There are three types of LME option contract; Traded Options, Traded Average Price Options (TAPO) and Index Options. Each contract is exercised through the LME Clearing System. Exercise Rules are specified by Exchange Rules which determine the times that exercise notification must be given, and for TAPO and Index Option contracts the Rules by which automatic exercise operates.
Traded options are exercised manually except on the last trading day when certain options are automatically exercised and an open futures contract is created. TAPO and Index Options contracts are exercised automatically by the LME Clearing System. For TAPO’s two open futures contracts are created, these contracts are equal and opposite except that one is created at the monthly average settlement price and the other at the strike price of the option. Exercised Index Options contracts are settled in cash. The settlement amount is the difference between the strike price of the contract and the relevant Index Settlement Price (ISP).