We were very encouraged to see that the London Metals Exchange (LME) had recently committed to introducing responsible sourcing requirements for its brands. This is quite ground breaking for an Exchange and as such we caught up with the LME while in London recently to understand more about this new initiative.
The LME is the largest global exchange for physical metals. In its own words,
“The LME is the de facto price formation venue for non-ferrous metals. The prices ‘discovered’ on our platforms are used as the global reference and basis for physical trading as well as in the valuation of portfolios, in commodity indices and metal ETFs. Our prices are trusted because the LME is the most liquid and most traded industrial metals market in the world and its global network of warehouses ensures the price is truly reflective of supply and demand.”
This paragraph is absolutely key. “Price discovery” is the cornerstone of LME’s business. Inaccurate or inconsistent price discovery may mean that over time the LME is used less as a global reference point. Brands then may look to list elsewhere. Market participants may also go elsewhere to hedge or trade.
Media reports point to the LME cobalt contract as recently trading at a significant discount to non LME published prices. Because the LME is a market of last resort, a buyer cannot pick and choose the actual source of their product. So if some of the supply is tainted or not worth as much as non LME cobalt, then it follows that all LME cobalt is tainted. So why would cobalt trade at such a discount?
A damning 2016 Amnesty International Report tells us why. Cobalt is a key ingredient for rechargeable batteries. More than 50% of the world’s cobalt supply originates in the Democratic Republic of Congo (DRC). Much of this is mined by hand by artisanal miners operating outside of authorised mining zones who typically lack basic protective or safety equipment and do not enjoy legal protections nominally provided by the state. Worst of all, many of these miners are young children. The Report found that the DRC Government was failing to adequately enforce the legal prohibition against child labour in artisanal mining. This was despite an international prohibition on the worst forms of child labour, DRC labour law and the country’s mining code which bans anyone under 18 from taking part in artisanal mining. The children interviewed by researchers described the physically demanding nature of the work they did. They said that they worked for up to 12 hours a day in the mines carrying heavy loads for less than US$2 a day.
Ethical considerations and business risk
So clearly we have a link here between business risk and ethical considerations. LME calls it “a commercial imperative”. This is a continuation of the trend we are seeing in Australia. That is, businesses are drawing the link between supply chain, sustainability and environmental factors relevant to their business and overall business risk. This is one of the reasons why the ESG-oriented process we employ across our investment universe is called the Ethical Partners Operational Risk Assessment (EPORA). Other reasons LME states for introducing the requirements are values related, for it to maintain its global leadership position and also to pre-empt and shape policy before regulatory change occurs.
LME is in the final stages of consultation for its Responsible Sourcing Requirements. In summary the process is as follows:
1. Brands must complete an OECD-based Red Flag Assessment on the supply chains of their operations
2. Brands will be then classified into “Higher-Focus” or “Lower-Focus”
3. “Higher-Focus” brands will be audited using OECD guidelines
4. LME can suspend or de-list brands that are in non-compliance
There are various stages of implementation from 2020 to 2024 to allow brands time to prepare.
The LME is to be applauded for requiring action from its listed brands on their supply chains. It is a significant and complex undertaking but one that is absolutely necessary to help eradicate significant human rights abuses in the mining industry globally. We also believe it reflects real leadership in both managing the business risks of issues with price discovery, and in the navigating the changing social, political and regulatory landscape.
Additionally, it appears the LME has agreed to treat all metals the same rather than placing an emphasis on just cobalt. This is a welcome development. However, we would also encourage the LME to:
• Require a full OECD Due Diligence Guidance for Minerals 5 Step Framework assessment from their suppliers, rather than just a red flag assessment. Alternatively, we wonder whether the LME should require its brands to submit a similar statement to their own UK Modern Slavery Statement, which must be signed off at board level and talk about the measures they are putting in place to mitigate their risks, and the progress they have made.
• Consider whether a self-assessment is an appropriate tool, or whether an independent assessment or audit of all their suppliers is a more credible way of ensuring their supply chains are safe.
• Require their suppliers to make their assessments public. At Ethical Partners we believe strongly in the importance of increased disclosure and public reporting from all parts of the supply chain.
• Consider extending its listing requirements to include addressing environmental and climate related risks too. Feedback suggests the LME is listening to concerns in this area. We’d also encourage the LME to require companies to include plans for remediation and compensation if supply chain slavery is found. The current LME proposal doesn’t appear to consider remediation by brands.
We will keep our investors up to date with future changes and developments from the LME in the area of responsible sourcing.
It is an important precedent for other global exchanges to consider.
During February 2022 the Fund returned 1.87% versus the S&P/ASX 300 Accumulation Index of 2.09%, underperforming the market by 0.21%. Over the past 12 months the Fund has returned 14.7%, outperforming its benchmark by 4.45% (after fees).