By Denny Thomas and Susan Thomas
HONG KONG/LONDON (Reuters) - The Hong Kong stock exchange agreed to pay 1.4 billion pounds ($2.18 billion) to buy the London Metal Exchange (LME), the world's biggest marketplace for industrial metals, underlining the shift in manufacturing's center of gravity to Asia.
The deal on Friday - still subject to approval by LME shareholders, who may well reject it - would give Asia's largest bourse a much-needed entry into a commodity trading platform and brings LME members closer to China, the world's biggest metals buyer.
Hong Kong Exchanges and Clearing Ltd (HKEx) <0388.HK> will finance the acquisition of the exchange, where total traded value was $15.4 trillion last year, through its existing funds and with a 1.1 billion pound bank loan, it said in a statement.
"This is a transformational milestone for Hong Kong," HKEx Chief Executive Charles Li told a presentation for analysts.
HKEx beat U.S. commodities exchange InterContinental Exchange
The LME, where trading in copper, aluminum, lead, nickel, tin and zinc is still carried out partly by open outcry around a circular floor in a bland-fronted building on Leadenhall Street, near the Bank of England, is a 135-year-old British institution.
"You have the biggest exchange, the biggest market and a lot of inefficiency," said Li, a former journalist and JPMorgan China banker, celebrating the win and the 12th anniversary of HKEx's listing.
"We as HK exchange are trying to breach that (gap), especially today with China's accelerated capital (moves). We are in the best position to address those market inefficiencies and that translates to greater revenue."
The board of the LME was unanimous in its decision to endorse the Hong Kong bid, which will be put to a LME shareholder vote that is likely before the end of July.
"ICE was a fantastic runner up and they fought the good fight, but the lure of all things eastern is what won it in the end," Sucden Financial Chief Executive and LME board member Michael Overlander said as he left the HKEx celebration party.
"I'm here in the reception and its buzzing in there, people are congratulating each other and slapping each other on the back. They really think they have got themselves a jewel in the crown," Overlander told Reuters by telephone from Hong Kong.
For the LME, HKEx offers a fast track into China and will strengthen its position in the major market against the Shanghai Futures Exchange, which trades in base metals.
The London exchange has also long sought to win approval from China's regulators to list its warehouses nearer customers in the country which accounts for 40 percent of copper consumption.
HKEx chairman Chow Chung Kong said HKEx was preparing to set up metal warehouses in China and launch products using the renminbi currency. "This will have huge benefits for mainland companies in terms of risk management," Chow said.
HKEx sat on the sidelines through a wave of exchange consolidation in major financial centers more than a year ago. At the time, HKEx was focused on forming joint ventures and alliances with its neighboring Shanghai and Shenzhen bourses.
It had since made clear its ambition to ramp up in commodities - a push led by Li.
Some analysts have expressed concern HKEx may be over-paying for the LME, which made a net profit of just 7.7 million pounds last year. The LME has operated on a non-profit model to keep fees low for the shareholder-members who own the exchange.
"The price is higher than some were expecting...," said Sam Hilton, analyst at investment bank Keefe, Bruyette & Woods.
"Investors are more likely to be negative on this news, but that's partly because the bears have been very negative whereas the investors who are positive on this deal are at best lukewarm," he said.
Concerns over the hefty price tag have partly weighed on the Hong Kong company's shares, with the stock down 9.4 percent this year, compared to a 4.3 percent rise in the benchmark Hang Seng index <.HSI.>.
The deal was concluded late in Hong Kong's day, after share trading closed.
"The (LME) shareholders were not going to give this away for a song," Overlander said. "At 1 billion pounds it would have failed, it wouldn't have been worth it."
The bidder still has to win over the LME shareholders, which include big banks Goldman Sachs
Some members, notably industrial users of metals, have opposed a sale partly because they fear the exchange's low-profit and unique structure of futures contracts could change.
"I am still not sold on the idea but I am certainly going to listen. You do wonder how they plan to extract that value over time," said Gavin Prentice, managing director of Marex Spectron and also an LME board member.
Due to the lopsided spread of shareholdings, the deal could fail if many small shareholders oppose the bid, which has to be approved by 75 percent of shares and 50 percent of shareholders.
"It's a lot less important who is buying it, it's a lot more important what they do with the exchange once they have got it," said Ivan Szpakowski, metals analyst at Credit Suisse.
Until at least January 1, 2015, HKEx has promised to preserve the LME brand, the operation of open-outcry trading and the prompt date structure of contracts traded on the LME.
It will also not increase fees for contracts currently traded on the LME, beyond the levels to be implemented next month, before January 1, 2015.
If approved, the deal will close in the fourth quarter, HKEx said. It will add to earnings after three years.
(Additional reporting by Lawerence White, Alison Leung, Melanie Burton, Eric Onstad, Maytaal Angel, Silvia Antonioli and Luke Jeffs; Editing by Michael Flaherty, Ian Geoghegan, Anthony Barker)