The London Metal ExchangeThe world’s premier non-ferrous metals market

Contents

The LME

Managing risk for the Global Metals Industry 01

About the LME 02

LME Services 04

Regulation and Compliance 07

Warehousing 08

Clearing and Arbitration 10

LME Contracts

Copper Grade A Contract 12

High Grade PrimaryAluminium Contract 12

Primary Nickel Contract 12

Special High Grade Zinc Contract 15

Tin Contract 15

Standard Lead Contract 15

Aluminium Alloy Contract 16

North American SpecialAluminium Alloy Contract(NASAAC) 16

LMEX – Base Metals Index Contract 16

History of the LMEThe LME was established in 1877 as a direct result of Britain’s industrialrevolution of the 19th century. This industrialisation led to the import actionof enormous tonnages of metal.

The merchants who sourced these materials and invested large sums ofmoney in the ventures, found themselves exposed to high financial risk. Sea voyages were long and hazardous, and the cargo could change in valuebefore it could be sold.

A market quickly developed whereby the metal could be sold for a futuredate based on the vessel’s estimated arrival time. In this way the merchantwas protected against a price fall and the purchaser was protectedagainst a price rise.

Over the years, the process of setting forward prices has become muchmore sophisticated and has been adopted by all sides of industry, usingfutures contracts, traded options contracts and derivatives of these, tomanage risk.

This is referred to as hedging and remains the main activity on the Exchange today.

The London Metal ExchangeManaging Risk for the Global Metals Industry

1

The London Metal Exchange ( LME ) occupies a uniqueplace in the world of non-ferrous metals and is the riskmanagement forum for this global market.

Situated in the heart of The City of London, the LME trades contractsfor future delivery and so helps discover what the price of metalswill be months and years ahead. This helps industry to plan forwardin a world subject to often severe and rapid price movements.

Member firms of the LME are prepared to assume the risk of pricemovement and LME contracts are available to hedge that risk.

Underpinning all this activity is the assumption that all contracts will be settled out by taking delivery of metal from a warehouse or delivering metal into a warehouse. While the vast majority ofcontracts are settled out for a cash difference, the fact that therecould be a physical transaction keeps the prices in the futuresmarket aligned to the physical.This feature is enormously importantto the proper function of the LME’s market.

All this activity, which generates business worth more than US $2,000 billion a year, takes place through the LME and itsmember firms. The time zone is ideal for global trading and it addsto the reasons why the LME has more than 90 per cent of theworld’s business in non-ferrous metals futures.

The work of the Exchange is felt more widely than people imagine,as it is through the LME that consumers achieve better and morestable product prices, and producers can plan their long termbusiness effectively.

For more than 125 years the LME has been a dominant feature in this market, and it is set to continue in that position far into the future.

N A S A A C

About the LME

The London Metal Exchange is the world’s premier non-ferrousmetals market. It has an international membership and morethan 95% of its business comes from overseas. It is a majorcontributor to the UK’s invisible earnings, responsible for morethan £250 million in overseas earnings each year.

Trading on the Exchange consists of open outcry trading, which takesplace in ‘the ring’, as the trading arena is known, supported by a 24 hourtelephone market and screen-based trading on LME Select.

The advantage of the open outcry periods is that they are highlytransparent. This gives added confidence to market users that the pricesestablished at the Exchange are credible and truly reflect the currentsupply/demand situation. Also, such is the liquidity at the Exchange thatthe future prices discovered through open outcry trading are recognisedand relied upon by industry in every part of the world.

CopperCopper is usedextensively today as aconductor of electricityand is frequently seen inelectrical devices as it iseconomical to use andhighly conductive.Copper is also an integral component in

the operation ofcomputers as the metal is used in theconstruction of integrated circuit chipsand printed circuit boards. The use ofcopper in computertechnology is becoming more

popular, replacingmaterials such asaluminium, allowingmanufacturers to bringdown the cost ofproduction and speed up processing time.

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3

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LME Services

The London Metal Exchange provides the global forum for allthose who wish to manage the risk of future price movements innon-ferrous metals. The Exchange has developed standardisedcontracts which assume that on falling due they will result inmetal either being delivered or received.

The primary roles of the LME are:

PricingEach day the LME announces a set of official prices, which are determinedfrom the open-outcry trading. This trading is highly liquid and trade andindustry has confidence that they properly reflect the currentsupply/demand situation.

These prices are used by industry worldwide as the basis for contracts forthe movement of physical metal throughout the cycle of production fromminers through smelters, fabricators, merchants and stockists to endusers, and back again through recycling processes.

HedgingHedging is the process of managing the risk of metal price change byoffsetting that risk in the futures market. Hedging can vary in complexityfrom a relatively simple activity, through to highly complex strategies,including the use of options.

The ability to hedge means that industry can decide on the amount of risk it is prepared to accept. It may wish to eliminate the risk entirely and cangenerally do so quickly and easily using the LME. Hedging by trade andindustry is the opposite of speculation and is undertaken in order toeliminate an existing physical price risk, by taking a compensating positionin the futures market. Speculators come to the futures market with no initialrisk. They assume risk by taking futures positions.

Hedgers reduce or eliminate the chance of further losses or profits, whilethe speculators risk losses in order to make profits.

DeliveryAll LME contracts assume delivery of physical metal. To meet this need,large stocks of metal are held in a worldwide network of warehouses,approved, but not owned, by the LME. Very few LME contracts result in a delivery, the vast majority of contracts being hedged contracts bought or sold back before falling due. As a result, deliveries that do take place,either in or out of a warehouse, strongly reflect the physical marketdemand and supply. The LME’s daily stock reports play a major part in the assessment of prices quoted by market makers.

SWORDDelivery against LMEcontracts is satisfied by thetransfer of warrants fromseller to buyer. A warrant is a paper document of title to the specified parcel ofmetal. Until 1999 thesepaper documents weretransferred by the sellerphysically delivering them to the buyer. However, in1999, the LME introducedits SWORD system toautomate this process.

SWORD, which is a jointinitiative between the LMEand the London ClearingHouse, is an electronicsystem for the productionand transfer of title of LMEwarrants. Its inceptioneliminated many of themanual processes involvedin the transfer of warrantswhich were both inefficientand subject to an elementof risk. SWORD bringssignificant improvements tooperational efficiency andgreater security through theimmobilisation of warrantswithin an approveddepository – The Depositoryand Clearing Centre –which is independentlymanaged by Bank One,NA, London Branch.

AluminiumAluminium is highlybeneficial to consumers,providing strong butlightweight products foruse in building andconstruction, transport,consumer durables,packaging andmachinery. Aluminium isalso particularly suited foruse in light bulbs due toits high electricalconductivity, low weightand good resistance tocorrosion. Almost allelectric lights, motors,appliances and powersystems depend on vastgrids of aluminium wire.The power supplyinfrastructure of some of the world’s largestbuildings are made ofaluminium.

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NickelNickel is by far one of the most useful metalsbecause of its strength,and corrosion resistance.It is used in countlessways and is a part ofalmost every alloy made.It is estimated that thereare over 300,000 usesfor nickel, these usesrange from being used incircuit boards, to beingused in over 65,000fasteners that keep theStatue of Liberty standing!The transportationindustry recognised thebenefits of nickel wheninstalling the WincroSuregrip stainless steelfloorplate for thepedestrian platformswithin Waterloo station.The long durability andlow maintenanceproperties of the productprovided a cost effectivesolution.

The Exchange provides the environment for trading. It has a statutory requirement of ensuring that business on its markets is conducted in an orderly manner, providingproper protection to investors. The members are theinstitutions involved in trading with each other and with their customers. Their regulatory requirements include the provision of the appropriate service to those customers.Regulation of the market is largely carried out by the LME,while the Financial Services Authority (FSA) is responsiblefor regulating the financial soundness and conduct of LMEmembers' business.

Approved as a recognised investment exchange (RIE) and conformingwith British and other international regulatory requirements, the LMEoffers, through price, volume transparency and audit trails, a legally safeforum for metal trading. As an RIE, the Exchange comes under the directjurisdiction of the FSA. LME members also operate in a strict regulatoryenvironment policed by the FSA.

It is the responsibility of the LME to regulate the operation of the market;the FSA is responsible for the authorisation and regulation and conductof business issues of the members of the LME.

Beyond this, both the Exchange and its members are subject toregulatory controls and input from various UK bodies and governmentoffices, as well as directives from the EU Commission in Brussels. In international trading, rules applied by overseas regulatory bodies such as the CFTC in the USA also have to be taken into account.

To ensure the observance of these regulations, the LME has acompliance department under the supervision of its executive director of regulation and compliance. This department monitors the market andmember positions in order to analyse developments and ensure that theLME is delivering its regulatory responsibilities.

Regulation andCompliance

6

USA

UK

Spain

Warehousing

Delivery against LME contracts is in the form of LME warrants,which are bearer documents of title enabling the holder to takepossession of a specified parcel of metal at a specified LMEapproved warehouse. Each LME warrant is for one lot of metal,the tonnage of which is dependent on the contractspecification. The front of the LME warrant displays informationabout the parcel of metal, including its brand, the exacttonnage, the shape and the location.

Warrants are issued by the warehousecompanies at the request of the owner of the metal once it is properly stored in an LME approved warehouse and the warehousecompany has ensured conformity with theLME’s Special Contract Rules for that metal.These rules include, but are not limited to, thetechnical specification of the metal, its shape,weight and bundling. The metal must also be ofa brand that is approved and listed by the LME.

The LME is very proud of its global role inproviding a pricing mechanism that reflects thestate of the markets it serves. An essentialfactor in achieving this aim is for the LME to

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Netherlands

Germany

Belgium

Italy

UAE

Singapore

Sweden

South Korea

Japan

maintain a spread of approved warehouselocations that reflects the needs of the users ofthe market and for the LME to monitor thoseapproved locations for continued compliancewith the listing criteria. Such criteria include theneed for locations to be in areas of netconsumption or to be ‘gateways’ serving thoseareas of net consumption and also for them tomeet the LME’s strict legal, taxation andcustoms requirements.

The LME is also active in assessing potentialnew locations as good delivery points. Thelocation criteria are designed to ensure thatmetal is stored in locations close to where it is

needed, rather than areas of production, thusassisting traders and industry in meeting theirlast resort delivery requirements as readily aspossible.

Ultimately, only a relatively small percentage ofLME contracts actually result in delivery, as thevast majority of contracts prove to be hedgingcontracts bought or sold back before fallingdue for settlement. As a result, the deliveriesthat do take place, either in or out ofwarehouse, will reflect the physical marketdemand and supply.

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ClearingThroughout the bulk of the London business day the LME's contractedclearing house, the London Clearing House Ltd (LCH) is operating toclear LME contracts.

Briefly, clearing works as follows: one clearing member contracts withanother clearing member to buy metal. Both clearing members enterdetails of the trade into the computerised matching system, which feedsthe information to the LCH.

Assuming both parties' entries agree on such details as time of trade,price, prompt date, contracting parties and volume, the trade is acceptedas matched.

The LCH is owned by three London exchanges (LME, LIFFE and IPE) and their memberships, who give it considerable financial backing by wayof £150M in bankers' guarantees, supported by a similar amount in theform of a members' default fund. As such, the LCH is able to assume acontractual role in these matched trades, becoming the buyer to theseller and vice versa. Therefore, clearing members are protected from therisk of business failure by other clearing members for that portion of theirmutual business that is cleared. Non-clearing members' and clients'contracts with clearing members are not affected by clearing; they remainprincipals' contracts.

The LCH is taking on market risk when it accepts trades into clearing andit covers that risk by requiring payment of margins - cash amounts thatcover the extent of any losses a contract might show. The LCH looks at all the positions of a member when calling margins, since a member mayhave some positions in profit and others in a loss situation, they will callmargins on the basis of the member's net position. Margins may beprovided in cash or by collateral such as bank guarantees.

ArbitrationLME arbitration is a private dispute resolution system, designed to settledisputes fairly, expertly and economically, without having to resort toaction in the UK or other courts. LME arbitration, being commercial, isdesigned, not for mediation or conciliation, but to result in outrightsettlement. The parties will have agreed that an independent decision ontheir dispute will be made by a third party, in the form of one, two, or eventhree arbitrators under the LME arbitration rules. The LME's arbitrationservice is generally recognised as the best available to the metals world.Indeed, so well regarded is the LME's arbitration facility that the service isused by a growing number of enterprises who have no direct involvementin metals.

Clearing andArbitration

ZincZinc is a material that hasgone through substantialchanges in the way that itis used and in the waythat it is perceived, bothby specialists and by the general public. The broad applicationsof coatings to protectiron and steel, brass,zinc alloys, sheet forconstruction and a rangeof chemical applicationsremain much the same,but new applicationshave seen the metal gaina new lease of life. Zinc is utilised in batteriesspecifically for hearingaids, portable computersand mobile phones andcan store six times moreenergy per pound asother battery systems.

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Copper Grade AContract

Copper was the first mineral that manextracted from the earth and along withtin gave rise to the Bronze Age. As the ages and technology progressed the usesfor copper increased. With this rapidincrease in demand, exploration for themetal was extended throughout the worldlaying down the foundations for theindustry as we know it today. Copper is anexcellent conductor of electricity, as suchone of its main industrial uses is for theproduction of cable, wire and electricalproducts for both the electrical and buildingindustries. The construction industryaccounts for copper’s largest usage insuch areas as pipes for plumbing, heatingand ventilation, as well as building wire andsheet metal facings.

High Grade PrimaryAluminium Contract

Despite being the most prolific metalon earth, aluminium only began to beused extensively once an inexpensivemethod for distilling it by means ofelectrolytic reduction was discoveredin the mid 19th century. It is extremelylight, pliable, has high conductivityand is resistant to rust. Little wonderthen that it has become the mostextensively used metal and morerecently the largest contract traded on the LME.

Primary NickelContract

In the mid 18th century nickel was firstisolated as a separate metal. Prior to thistime it was found in copper mines andthought to be an unsmeltable copper ore.It is said that this lack of malleabilitycaused it to be named after the devil (Old Nick). Nickel can resist corrosionand maintains its physical andmechanical properties even when placedunder extreme temperatures. Oncethese properties were recognised thedevelopment of nickel began. It wasfound that by combining nickel withsteel, even in small quantities, thedurability and strength of the steelincreased significantly as did itsresistance to corrosion. This partnershiphas remained and the production ofstainless steel is now the single largestconsumer of nickel today. This highlyuseful metal is also used in theproduction of many different metal alloysfor specialised use.

Introduction to LME ContractsLondon Metal Exchange futures and traded options contracts are available for all exchangetraded, non-ferrous metals. The LME also operates futures and traded options contracts basedon an index (LMEX) of the six primary contracts.

America

Asia

Europe

Oceania

Africa

41

31

21

3

3

%World Production

Building

Electrical

General Engineering

Light Engineering

Transport

Other

48

17

16

8

7

4

%Industrial Consumption

Transport

Packaging

Construction

Machinery

Electrical

Consumer Durables

Other

26

22

22

8

8

7

7

%Industrial Consumption

Europe

America

Asia

Oceania

Africa

33

29

24

9

5

%World Production

Stainless Steel

Non-Ferrous Alloys

65

12

%Industrial Consumption

10

8

5

Other Steel Alloys inc Castings

Electroplating

Others, inc. Chemicals

Europe

America

Asia

Oceania

Africa

37

24

19

15

5

%World Production

The production and consumption figures used for this and all the contracts are derived from a variety of tradeassociations, technical publications and industry analysts.

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TinTinplate is the primarymaterial for food canningand shares the beveragecan market withaluminium. The humble‘tin’ can, so often takenfor granted because of its long history andpresent familiarity, isactually the simplest andmost efficient way ofpreserving a vast rangeof foods. The tin coatingon the tinplate can,provides a non-toxicsurface and prevents

corrosion; it also helps inthe various can-makingprocesses. Tin is avaluable metal with abroad range of uses inindustries such aselectronics and is alsothe fluoride carrier intoothpaste. It can also berecycled from several ofits end-uses, and thisproduces ‘secondary’ tin ingots, which can bere-used.

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LeadLead plays a major part in our everyday lives. Wesafely use and recyclelead in dozens ofimportant consumer,industrial and defenceapplications, includingbatteries for automobiles,industrial forklift trucks,waterproofing material,electronics andcomputers to name but a few. Because of its high density, capability

and availability, lead is also an outstandingmaterial for radiationshielding. Major progressin the medical field’s useof radiation for imagingdiagnostics such as CAT scans can bedirectly attributed to theuse of sophisticated lead shielding to protectpatients, healthcareprofessionals and the public.

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Special High GradeZinc Contract

Zinc is commonly mined as a co-productwith lead and both metals have growingcore markets for their consumption. Forlead this is its use in batteries and for zincthe main market is galvanising, whichaccounts for almost half its modern daydemand. Zinc’s electropositive natureenables metals to be readily galvanised.This provides an excellent protective coat against corrosion for building structures,vehicles, machinery and householdequipment.

TinContract

Tin, like copper, was one of the firstmetals mined and its excellent qualitiesand shiny finish made it a highly soughtafter commodity. Particularly liked for itsfusion abilities in the making of alloys,notably bronze, and its non-toxicqualities, tin was soon traded in manyparts of the world. Not surprisingly itwas traded on the LME from themarket’s outset in 1877. Today it isused in the production of bronze,pewter and die-casting alloys and, inmodern engineering, to make tungstenmore machineable. However, thelargest uses for tin are for theproduction of solder and for tin plating(providing an attractive coating to ironand steel products).

Asia

Europe

America

Oceania

Africa

43

30

19

6

2

%World Production

Zinc Semi – Manufacturing

Galvanising

Brass & Bronze

Zinc Alloying

Chemicals

47

19

14

9

8

3

%Industrial Consumption

Miscellaneous

Asia

America

Europe

Africa

Oceania

75

18

5

1

1

%World Production

Solders

Tin Plate

Others

Alloys

PC Stabiliser

Tinning

32

27

17

14

6

4

%Industrial Consumption

Standard LeadContract

Apart from periods of internationalconflict when trading was suspended,the LME has long been themainstream of free trade in lead. This metal has had a checkeredhistory, being very soft and pliable andhighly resistant to corrosion; it wasideal for use in plumbing as well as forthe manufacture of pewter. In the early20th century the automotive industryexpanded and new areas ofconsumption – batteries and petrol –created an enormous market. Storagebatteries remain the main outlet butlead free fuels have caused a declinein its usage. Ironically, environmentalissues have brought about new usesfor the metal, particularly in thehousing of power generation units toprotect against electrical charges ordangerous radiations.

Asia

America

Europe

Oceania

Africa

33

33

28

4

2

%World Production

Batteries 71

12

7

6

3

1

%Industrial Consumption

Pigments & Other Compounds

Rolled & Extruded Products

Shot/Ammunition

Cable Sheathing

Alloys

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NASAAC

With a modified A380.1 specification,this new aluminium alloy contract wasdesigned following intensive discussionswith all segments of the North Americansecondary aluminium industry. It has aspecification that reflects the productionand consumption of aluminium alloy inthe US, Mexico and Canada.

The use of aluminium alloy, particularlyfor the production of lightweight engineparts, has been steadily growinginternationally over recent years. Themain consumers of aluminium alloy; automanufacturers, use different grades ofalloy in different regions of the world. Forthis reason, the LME entered talks withsecondary smelters, scrap dealers,consumers, traders and merchants inNorth America to develop the LME’s first regional contract.

N A S A A C

LMEX

The LMEX contract is an index of the 6primary base metals contracts traded onthe Exchange. It is weighted on the basisof world production and volumes tradedon the LME. It is specifically designed togive a single liquid reference price. Thisprovides the investment community withthe opportunity to diversify portfolios toinclude an element of industrial metalswithout the complications of physicaldelivery inherent to the underlyingcommodity contracts. Independentacademic research simulating thecontract over 15 years has shown thatthe value of LMEX has little correlationwith the equity and bond markets.Consequently the research concludesthat at certain times the investor mayenjoy superior returns at lower risk whenLMEX is included in their portfolio.

Aluminium AlloyContract

The qualities that make the primary metalso successful have also led to theproduction of over 100 gradesof aluminium alloys, where variousamounts of other metals are combinedwith aluminium to give strength andspecific characteristics for particularusage. The LME contract reflects gradesused in the production of automotiveengine parts, but is equally suitable as arisk management tool for other alloyswhen they are priced basis a discount orpremium to the LME contract. Much ofthe world production of aluminium alloysis sourced from recycled material. Theenvironmental advantages of thisrecycling activity combined withaluminium’s inherent benefits is likely tosee aluminium alloy assume an evenmore significant market in tomorrow’sworld.

There are many grades of aluminium alloy whichare produced for specialist uses. Creditablefigures defining these uses are not available so no charts are given. However, the LMEcontract allows for the delivery of aluminiumalloy conforming to one of 3 grades. They areA380.1, 226 and D12S.

North American Special Aluminium Alloy Contract

Base Metals Index Contract

Aluminium AlloyAluminium is mixed withsmall amounts of copper,magnesium, zinc, andother elements to formaluminium alloys. Theadded elements givealuminium strength andadditional properties thatmake it a very usefulmetal. A large proportionof aluminium alloyproduction goes to thepackaging industry foruse in such items asbeverage cans, bottlecaps, foil wrappers and food containers.

The construction industry uses aluminiumalloys extensively forapplications such asgutters, panels, roofingand window frames.Manufacturers ofautomotive equipmentsuch as Honda, usealuminium alloys in theproduction of pistonheads which form anintegral part of today’smotor engine.

The simulated past performance of LMEX, available from the LME, contains a statement explaining how the figures were calculated.The calculations were based on certain assumptions: different assumptions may have produced different results. The past performance

of metals prices and the simulated past performance of LMEX are not guarantees of the future performance of metals prices or of LMEX.

LME contracts may only be offered or sold to United States foreign futures and options customers by firms registered with the Commodity Futures Trading Commission (CFTC), or firms who are permitted to solicit and accept money from foreign futures and options

customers for trading on the LME pursuant to CFTC Rule 30.10.

This document is published by The London Metal Exchange Limited. To the best of the publisher’s knowledge and belief, statements made are correct at the time of going to press. All such statements and all opinions expressed herein are published

for the general information of readers but are not to be taken as recommendations of any course of action. The publisher accepts no liability for the accuracy of any statement or representation.

© The London Metal Exchange Limited, 2003. No portion of this publication may be reproduced without written consent.

The London Metal Exchange logo is a registered trade mark of The London Metal Exchange Limited. LMEX and its logo are trade marks of The London Metal Exchange Limited. All other trade marks are acknowledged.