By Pratima Desai
LONDON (Reuters) - The London Metal Exchange (LME) is studying Hong Kong as a location to expand its global metal warehouse network, five sources with knowledge of the matter said, hopeful success there might open the door to mainland China, its ultimate target.
Registering warehouses in China, the world's largest consumer of industrial metals, to store metal traded on the LME has been a strategic aim since Hong Kong Exchanges and Clearing (HKEx) bought the LME in 2012 for $2.2 billion.
In a presentation made to the LME's warehousing committee in December, seen by Reuters, the exchange said companies in the region had indicated interest in Hong Kong as a place to store industrial metals as an alternative to mainland China.
"Around ten domestic and regional LME market participants ... have recently expressed interest in this initiative directly to the LME or through the HKEMCA (Hong Kong Energy, Mining and Commodities Association)," the LME's presentation said.
"An LME warehouse in Hong Kong could be seen as a showcase for in-depth cooperation between Mainland China and Hong Kong," the presentation said. It also said Hong Kong as a good delivery location (GDL) "closes gaps in the LME's delivery network that have frustrated some Chinese customers".
HKEMCA did not respond to a request for comment.
"The LME actively engages with industry participants worldwide to ensure the LME warehouse network continues to provide maximum global connectivity for the metals community," the LME said in response to a request for comment.
"When assessing potential new delivery points, we consider a number of important criteria ... we also discuss these with the relevant LME advisory committees before communicating with the market."
No timeline for the proposal was given by any of the sources, but several hurdles stand in the way of listing Hong Kong as a (GDL), the sources said.
Two sources said they were wary of the idea of investing in Hong Kong because of the risks associated with China's growing influence over foreign firms and individuals in the territory.
Concern about China's power in Hong Kong could be reinforced or eased by whether China respects a decision by a Hong Kong court to order the liquidation of property giant China Evergrande Group.
Three of the sources said the idea was flawed due to the prohibitive costs of storage space in Hong Kong and the fact that its imports of industrial metals such as copper and aluminium traded on the 147-year-old LME are insignificant.
"The LME sees this as a potential gateway into China, but the political situation isn't healthy, people don't want to invest in Hong Kong. It is de facto China," one of the sources said.
"Hong Kong authorities would need a green light from China, where they will come up against the same issue they have had all these years; local resistance and regulatory hurdles."
Chinese rules and regulations alongside resistance from local competitor Shanghai Futures Exchange (ShFE), have frustrated the LME's attempts to expand its network of warehouses to China.
However, things have changed due to pressure on Chinese exchanges to innovate and expand throughout Asia. ShFE is looking at expanding its metals warehousing network outside China, while the LME is planning to launch new metals contracts using prices from the Shanghai Exchange.
ShFE and the China Securities Regulatory Commission, which would approve LME warehouses in China, did not respond to requests for comment.
Typically the LME would only approve locations in countries which consume and import large amounts of industrial metal.
Hong Kong's imports of industrial metals such as copper and aluminium are a small fraction of global supplies.
"Hong Kong is not a traditional centre for base metals storage and does not currently attract significant inflows of metal due to cheaper nearby ports," the LME said.
Good delivery locations in the LME's Asian network include ports in Taiwan, South Korea and Malaysia which are all cheaper places to store metal, the sources said.
Singapore is also included in the LME's network, but it is more expensive and though it doesn't consume large amounts of metal, it is used as a transit location.
Two of the sources said rent in Hong Kong could potentially amount to four times the maximum rent warehouses in the LME's system can charge, which for aluminium, copper, zinc and nickel is around 50 U.S. cents a metric ton.
This the LME acknowledged by saying in the presentation that warehouse rents would have to be subsidised by the Hong Kong Government "to be a commercially viable option".
Other support for LME warehousing from the Hong Kong government could include "recently warranted LME metal given "fast tracked" customs status across the mainland border".
The Hong Kong government referred Reuters to HKEx in response to a request for comment. HKEx said "this is an LME matter".