The exchange has yet to make a decision, but on Thursday launched a formal three-week
discussion process on the possibility of banning Russian metal, potentially as soon as next
month.

In practice, a ban would simply mean that metal from Russia – which accounts for about 9 per
cent of global nickel production, 5 per cent of aluminum and 4 per cent of copper — could no
longer be delivered into any warehouses around the world in the LME network, which store
metal used to deliver against futures contracts when they expire.

But the debate, and potential fallout, provide a stark case study of how deeply the LME is
intertwined with all corners of the physical metals industry. Despite being a private company
owned by Hong Kong Exchanges & Clearing, the exchange’s decisions have far-reaching
consequences for the way in which metal is priced and traded globally.

To be clear, the vast majority of global metal is sold from producers to traders and consumers
without ever seeing the inside of an LME warehouse. And big producers, including top
Russian groups United Rusal International PJSC and MMC Norilsk Nickel PJSC, almost
never sell their metal directly on the LME.

First, it’s a market of last resort for the physical metals industry: stocks of metal in the global
network of LME warehouses can be drawn down in moments of shortage, and in times of
glut excess inventories can be delivered to the LME.

In recent months, traders have been bracing for a glut, particularly in aluminum, amid
concerns about the state of the global economy. As some buyers shun Russian metal, traders
had expected that aluminum from Rusal would be among the first to be delivered to the LME
– with some expecting hundreds of thousands of tons of inflows. Rusal has denied it is
planning to deliver “large quantities” of its metal to the exchange.

Should the LME go ahead and ban new deliveries of Russian aluminum, that would remove
the potential overhang of stock. When Bloomberg first reported on the LME’s plans for a
discussion paper last week, aluminum prices jumped as much as 8.5 per cent — the biggest
intraday rise on record — as traders who had been anticipating an inflow of Russian metal
rushed to reverse their short bets. As of Friday, prices were up about 10 per cent from last
week’s 19-month low.

Of course, the LME is considering this drastic step because it’s worried about a similarly
disruptive possibility if it doesn’t take action: that Russian metal that many consumers refuse
to touch will flood onto the exchange and cause its prices to stop being useful as global
benchmarks.

In fact, one of the reasons it is considering a quick rollout of any possible ban is that a
decision to proceed could prompt a rush by holders of Russian metal to deliver it on the
exchange before the restrictions came into place.

Any move by the LME would also have ramifications beyond the warehouse flows. For
example, some contracts between producers, traders and consumers stipulate that the metal
should be “LME deliverable,” meaning that a ban by the LME could lead to contracts being
broken.

Banks often insist that the metal they finance should be LME deliverable, because they want
to be sure that, in the event of any problems, it could be sold easily on the exchange. And
many traders rely on the fact that metal can be delivered to the LME when they use LME
contracts to hedge their physical inventories — should they choose to, they can close the
hedge by simply delivering metal.

As a result, any move by the LME could create headaches for Rusal and Nornickel, as well as
their biggest customers. Glencore in particular has a vast multi-year contract to buy
commodity-grade aluminum from Rusal.

There’s already an expectation at the companies that the consultation process launched by the
LME will make it more difficult for customers of Rusal and Nornickel to fund working
capital using the metal as collateral, according to people familiar with the matter.
The simple fact of the discussion is likely to cause Nornickel’s sales to Europe to drop
significantly, given that it creates uncertainty at a crucial time of the year for sales
negotiations, one of the people said.

That means that a ban by the LME could lead to the Russian companies being forced to
accept lower prices.

Nornickel already was weighing options to redirect some sales to the east if sanctions against
Russia didn’t allow it to maintain its current sales structure, chief executive Vladimir Potanin
said in an interview with RBC TV in September.

“At the end of the day, this won’t change supply-demand balances, but it does mean we’ll
have metal looking for a home,” said Colin Hamilton, managing director for commodities
research at BMO Capital Markets. “Someone somewhere will buy that metal at a discount.”