London Metal Exchange faces prospect of fines over nickel market chaos
Financial Conduct Authority launches enforcement action against metals exchange over decision to freeze trades
Harry Dempsey and Laura Noonan in London MARCH 3 2023
The London Metal Exchange faces the prospect of hefty fines and censure after the UK’s top financial regulator launched an enforcement investigation into the company over the decision to freeze nickel trading during last year’s market mayhem.
The Financial Conduct Authority said the probe, the first such action it has launched against an exchange, would include actively monitoring the LME’s efforts to improve its conduct, controls and governance.
The investigation will also examine the conduct, systems and controls in place at the LME between the start of 2022 and March 8, when it froze nickel trades in response to skyrocketing prices. The investigation is likely to take several years and could result in a fine for the LME.
In a separate statement, the Bank of England said that it planned to appoint an independent monitor to report regularly on the progress by LME Clear, the exchange’s clearing house, to improve its governance and risk management.
Nickel prices more than trebled on a single day last March as fears of sanctions against Russia, a top exporter, collided with a bet on falling prices by Tsingshan, the world’s largest stainless steel producer. This led the LME to suspend and cancel huge volumes of nickel trades.
The trading crisis threatened to cause a wider market meltdown and has eroded confidence in the functioning of the nickel market.
The enforcement action follows a review by the BoE into LME Clear and an independent review by consultancy Oliver Wyman, which the central bank said collectively found “several shortcomings across LME Clear’s governance, management and risk management capabilities”.
The LME said it “will co-operate fully” with the FCA’s enforcement investigation and “will continue to take the appropriate steps to ensure the long-term health, efficiency and resilience of its market”. It added that it would resume nickel trading during Asian hours on March 20 in a bid to boost trading liquidity.
Chris Clark, a derivatives partner with law firm CMS, said the enforcement action was no surprise. “Following the cataclysmic events of last year, when metals prices spiralled out of control, it became clear how poor LME’s market oversight and suspension processes are,” he said.
Last April, the UK financial regulators announced they would review the governance and risk management of the exchange and its clearing house surrounding the decision to suspend and resume nickel trading.
The scope of the FCA’s enforcement investigation appears to omit the LME’s decision to cancel billions of dollars worth of nickel trades, which have become the focus of near $500mn in lawsuits by hedge fund Elliott Management and market maker Jane Street. The FCA declined to comment on why its enforcement action makes no reference to the cancellation of trades.
The LME introduced several measures in the wake of the nickel trading chaos to improve controls, such as price move limits and disclosure of over-the-counter trading, which is done outside of the exchange bilaterally between two parties.
The FCA said that it was “encouraged by the LME’s focus on increasing the transparency of OTC trading to support robust risk management in its on-exchange trading.”
Clark predicted there would be further probes of the mayhem. “The FCA’s requirement for banks to report on trading activities in metal has been in place for the last few months and certainly since the regulator’s statement in April of last year,” he said. “So it suggests that today’s action by the regulators is only the start of a process leading to strong enforcement.”
Independent report criticises exchange for lack of circuit breakers in March nickel crisis
Harry Dempsey JANUARY 10 2023
The London Metal Exchange should strengthen its rules and oversight to prevent short-term market distortions, according to an independent review of March’s nickel market chaos which found the marketplace had insufficient tools to stop prices spiralling out of control.
The report, conducted by consultancy Oliver Wyman, laid out further details on the depth of the crisis in the run-up to a decision by the LME, the world’s largest hub for metals trading, to suspend nickel trading for a week and cancel billions of dollars’ worth of trades.
LME’s radical step on March 8 came after nickel prices surged 270 per cent over three trading days to exceed $100,000 per tonne, when a bet on falling prices by China’s Tsingshan, the world’s largest stainless steel producer, collided with fears of sanctions on Russia, a large nickel producer.
The report found that one of the key problems that stopped the LME from doing more to prevent the crisis was that it lacked visibility on the size of two large short positions held in over-the-counter derivatives, which are private transactions directly between two parties off the exchange — one of which was known to be held by Tsingshan.
However, it also said that while the LME typically looked for indications that traders were trying to corner the market with large positions on particular dates, it said the LME “did not routinely” investigate large net positions and ask members to explain them. “This reduced the likelihood of identifying the scale of over-the-counter positions,” it said.
Matthew Chamberlain, chief executive of the LME, said in an interview that had the data on off-exchange positions presented in the report been available to the exchange, then “different decisions could have been taken on March 7”.
The report also highlighted shortcomings in the LME’s mechanisms to cool down outsized price moves, pointing out that the exchange did not have circuit breakers or limits to restrict or halt trading for longer periods. “In this instance, the independent review believes that where price increases were driven by short closing in thin liquidity, longer halts to trading would have been the most helpful.”
The review also adds to mounting evidence on the gravity of the crisis and stress on the 146-year-old exchange before it halted and reversed trading.
The LME is facing investigations from its regulators at the Bank of England and Financial Conduct Authority over its handling of the crisis, and is defending itself against lawsuits totalling $470mn by hedge fund Elliott Management and market maker Jane Street over the cancelled trades.
“The independent review has confirmed our concerns that the LME lacked the systems and controls to manage through the March 2022 nickel crisis, but it is essential that a robust regulatory review addresses how LME failed in its regulatory function,” said Jennifer Han, head of global regulatory affairs at the Managed Funds Association, a US lobby group.
The report found that $1.4bn of over-the-counter margin calls had been missed on March 7, more than 10 times the six-month average. At least three of the 10 largest short position holders were overdue on paying margin towards a subset of LME members when prices pushed higher on March 7, the report added.
On March 7 LME Clear, the exchange’s clearing house, suspended intraday margin calls at 13:30 for the rest of the day after demanding $7.5bn. The price increase of nickel that day, 69 per cent, was more than three times the size of the largest ever price move.
In response, the LME said it would prepare an implementation plan for the report’s recommendations, to be published by the end of March.
It pointed out that it had already taken some measures, including implementing daily price limits and over-the-counter position reporting for all physically delivered metals. “The publication of this report is an important further step in rebuilding confidence in the LME nickel market,” it said.
LME claims $20bn nickel trade chaos threatened to tip it into ‘death spiral’
Exchange’s defence against judicial review says level of margin calls would have bankrupted multiple clearing members
The LME has been criticised heavily for its decision to suspend and cancel nickel trades during the unprecedented market chaos in March
Harry Dempsey NOVEMBER 29 2022
The London Metal Exchange claims that $20bn of margin calls would have led to the simultaneous bankruptcy of multiple clearing members* and created systemic market risk, according to its defence against a $470mn lawsuit over the cancelling of billions of dollars worth of nickel trades in March.
In court documents detailing its case against judicial review claims filed by hedge fund Elliott Management and market maker Jane Street, the world’s largest metals marketplace said the staggering surge in initial margins — cash handed over to make a trade — had threatened to tip the LME into a “death spiral”.
The requirement for $19.75bn worth of intraday margin calls — some 10 times larger than the previous record on March 4 — came after nickel prices surged 230 per cent in one day on March 8 and threatened to cause a systemic collapse in the metals market.
Elliott Management stood to profit by hundreds of millions of dollars if the nickel trades had been allowed to stand and it claimed that the exchange acted “unlawfully” by exceeding its powers in cancelling the trades.
The LME has been criticised heavily for its decision to suspend and cancel nickel trades during the unprecedented market chaos, facing accusations that it should have acted sooner to suspend trading, which would have avoided the need to reverse trades.
The LME said in a statement on Monday: “Elliott’s and Jane Street’s grounds for complaint have no merit and are based on a fundamental misunderstanding of the situation on 8 March and the decisions taken by the LME. All the actions taken on 8 March were lawful and made in the interest of the market as a whole.”
The court documents released on Monday show that on March 7, when nickel prices almost doubled in one day, three members missed initial margin calls due for payment by 9am and margin requirements increased by $7bn, the LME still deemed the market to be orderly.
It believed there were legitimate geopolitical and macroeconomic reasons for the price increase — namely potential sanctions on large nickel producer Russia.
The historic market chaos was further stoked by a large bet on falling prices held by the world’s largest stainless steel producer, Tsingshan, in the over-the-counter market, which the LME was not aware of.
LME Clear, the clearing house for the exchange, calculated on March 8 — when prices almost doubled in frenzied trading before the market was suspended — that a minimum of $19.75bn of intraday margin calls would have to have been paid on that day.
The LME said this estimate was “conservative” because it was based on a price of $80,000 per tonne of nickel, while prices had peaked at above $100,000 per tonne.
The court documents state that “the risk was greater than appreciated: the defendants’ subsequent analysis has shown that the margin calls would have caused at least seven clearing members to go into default”.
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If those members had defaulted on initial margin payments, the documents say, then LME Clear would have been forced to have taken on a large short nickel position that would have resulted in a $2.6bn loss. That in turn would have caused a cascade of clearing members defaulting as LME Clear would have been forced to seek contributions from non-defaulting members to cover the loss.
The exchange added: “This disorder presented a systemic risk to the nickel market itself and to the LME’s wider market as a whole.”
The LME has introduced several measures since the market chaos including limits on daily price movements and reporting requirements on OTC positions, some of which were opposed by market participants when the LME had previously tried to make such reforms.
Elliott Management and Jane Street declined to comment.
Surge in nickel prices threatened to blow $2.6bn hole in key LME entity
Fullest accounting to date of incident in March shows clearing house was under severe strain
Harry Dempsey and Philip Stafford in London DECEMBER 1 2022
A surge in nickel prices in March threatened to topple a London Metal Exchange entity designed to keep troubles in a single market from infecting the financial system, according to the fullest accounting to date of a crisis that has shaken confidence the 145-year-old venue.
LME’s clearing house faced a $2.6bn loss in early March when the price of nickel jumped more than 200 per cent in a single day, while a stability fund that provides a further layer of protection would have been nearly wiped out, legal filings published this week show. The disclosures shine light on why senior executives made the highly irregular decision to halt trading and cancel billions of dollars of deals in a fraught period on March 8.
The group’s filings came as it combats a $470mn legal challenge launched by US hedge fund Elliott Management and Jane Street. The LME, which is owned by Hong Kong Exchanges and Clearing, has been accused of failing to perform its regulatory duty when it cancelled the trades.
Prices for nickel, used in steelmaking and electric car batteries, surged 230 per cent in a day, leaving LME members potentially needing to kick in $20bn in margin payments, cash required for trading. That was 10 times higher than the previous record of March 4 and a level that threatened to tip it and its members into a “death spiral”. At the centre of the chaos was a huge bet on falling prices made by Chinese steel producer Tsingshan, which was upended by the big move higher in prices.
The LME said it was forced into its emergency measures as up to seven of its members could have defaulted on payments due to its clearing house if it had let eight hours’ worth of trades stand.
But the legal filing also underscored that the LME’s own clearing house, set up to protect the market against defaults, was also in severe danger, with the LME potentially unable to trade other metals and posing “a significant systemic risk to the wider financial system”, it said. The LME declined to comment further.
A clearing house stands between two parties in a trade and helps prevent a default from cascading through the market.
The LME had concerns about the market the day before the main incident on March 8. On March 7, surging prices forced it to make an unprecedented nine intraday calls for more margin, totalling $7bn.
An internal meeting at 1.45pm London time on March 7 decided the clearing house would not ask for any more margin calls, which it admitted was “extremely unusual and a departure from internal policy”. The market did not close until 7pm.
Adrian Farnham, then chief executive of the clearing house, stated that the measure was “no more than a temporary stop-gap and was not sustainable beyond the end of the day: LME Clear could not continue to be under-collateralised against member default”, the filing said.
UK rules mandate that clearing houses must measure their liquidity and credit exposures to their members on “a near to real-time basis”.
Matthew Chamberlain, LME chief executive, stated that at the end of the day, in his view, the market remained orderly as traders tried to reprice assets in the wake of Russia’s invasion of Ukraine and the imposition of sanctions.
Prices surged again on March 8, pushing up margin calls, with the LME later estimating that seven members could have defaulted. If that had happened the LME would have been forced to take on the short positions of the defaulting members, it said. The positions, if sold at prevailing market prices, would have resulted in a loss of $2.6bn for the exchange.
But the LME said the size of losses would have eaten up both the clearing house default fund that protects the market as a whole against a sudden collapse of one of its members, and the clearer’s own funds that are used as a backstop, and still left a shortfall of $220mn.
The clearing house would have needed to ask its members for at least $1.2bn as soon as possible, and to find fresh funds of its own. If more members defaulted on nickel trade payments it could have cost the LME an extra $170mn and required it to take on thousands of short positions in other metals markets.
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The LME insisted in the court documents that its decision to cancel trades was based on the need to maintain an orderly market and its regulatory objectives, denying that it was influenced by LME Clear’s exposure.
Sarah Taylor, a partner at HFW, a law firm, said the severity of the potential ramifications for the metals market could favour LME’s defence that it was motivated to comply with the regulatory obligation for its clearing house to remain fully collateralised.
“This potentially does provide an answer to Jane Street’s claim,” she said. “If the LME can establish that its regulatory obligations would have been breached had it not cancelled the [March 8] trades, it will be difficult for the claimants to show that this was an unreasonable decision.”
The Financial Conduct Authority and the Bank of England, the LME’s main regulators, are conducting a review into the LME’s handling of the incident. Consultants Oliver Wyman are also leading an independent review into the circumstances leading up to the nickel market squeeze. The report is due by the end of the year.
Colin Hamilton, managing director of commodities research at BMO, said the detailed defence provided further details on how severe the crisis, sparked off by the niche nickel market of approximately 3mn tonnes per annum, could have been.
“The fact that a market so small could cause severe financial strain will undoubtedly catch the eye of the regulators,” he said.
Traders warn LME nickel benchmark disconnected from global market
Metal pricing hit as thin volumes and higher financing costs force investors to sidelines
Harry Dempsey DECEMBER 14 2022
Traders are warning that thin volumes and erratic trading have disconnected the price of nickel on the London Metal Exchange from the rest of the global market.
The metal fell 3.8 per cent on Tuesday to $28,250 after rising as high as $33,575 a tonne last week, with the spike underscoring the severity of traders’ nine-month retreat from the LME.
Nickel for delivery in three months was $293 more expensive on the LME than the spot price at Monday’s close, marking the biggest contango — where the futures price is higher than the spot price — for the metal in at least a decade, according to Bloomberg data.
The dislocation is creating a problem for producers, traders and consumers, who rely on the LME’s price as the world benchmark for their own deals and as a price guide for lower quality versions of the metal. Nickel is a key ingredient in steelmaking and electric car batteries.
Traders believe the futures price is out of line. Its average has been roughly $15,000 a tonne in the years before the nickel crisis.
“Nobody believes it reflects the fundamentals,” said Nikhil Shah, analyst at CRU Group. He argued the price should be in the low $20,000s as the global economy entered a slowdown and countries such as Indonesia raised production levels.
For the LME the nickel market has become a considerable issue since Russia’s invasion of Ukraine, because Russia is one of the main global sources of the metal for its contract.
The 145-year-old exchange has been trying to rebuild its reputation with users after being forced to cancel a day of trades in March when a short squeeze more than tripled nickel prices in a day, to more than $100,000 a tonne. One of its biggest users, Tsingshan, the world’s largest stainless steel manufacturer, was caught out when Russia’s invasion of Ukraine raised fears over supply disruptions.
Some furious users have scaled back the volume of trading and the thinner market is exacerbating price moves. Average daily volumes on the LME were down 60 per cent at 35,400 contracts in November compared with January.
The LME contract represents high purity nickel, but other lower grade nickel products highlight the contract’s disconnect from other markets.
Ferro-nickel, used in stainless steel, was trading at a $100-$300 a tonne discount to the LME price in November 2021, but that discount swelled to $5,000-$6,000 last month, according to Fastmarkets.
Another, nickel pig iron, is trading at roughly $19,600 a tonne, according to data provider Argus. It can be upgraded into LME-grade nickel with further processing at a cost.
“At $30,000, who is buying [LME nickel]?” said one trader. “If you can buy the meat and casing for $22,000, then it makes no sense to buy a sausage for $30,000.”
Malcolm Freeman, chief executive of Kingdom Futures, a commodity brokerage, said some European customers that trade into China have been asking to hedge their risk using the rival Shanghai Futures Exchange (SHFE) nickel contract as a peg. The Shanghai price is trading at about $30,000, where normally it would closely track the LME price.
“There is now a major disconnect between LME nickel, SHFE nickel and the nickel pig iron price,” said Colin Hamilton, managing director of commodities research at BMO Capital Markets. “We see nickel pig iron prices as a better gauge of underlying physical demand.”
Al Munro, a broker at Marex, said higher global interest rates were layering on costs to finance metals trading. “Nickel of all the metals has been impacted most substantially by the higher credit costs,” he said. “On a metal that expensive, it is substantial — as a result of which, many banks have stepped aside.”
Furthermore, the LME has also raised the amount of margin that investors must post to backstop their trades to avoid the kind of market meltdown that was on the verge of unfolding in March. “It has become prohibitively expensive to trade nickel,” said Munro.
One trader blamed the LME for further stoking the thin market by closing trading during Asian hours, which was blamed for accelerating the short squeeze in March.
“They don’t want to have a repeat of the situation earlier this year but it doesn’t make for liquid markets,” said Geordie Wilkes, head of research at Sucden Financial.
The LME said it was working on reopening Asian trading of nickel as a priority. “This would revitalise the arbitrage opportunities and help liquidity to pick up. We hope to announce a return to Asian hours trading very soon.”