LME boss calls for a review of private deals in nickel probes

UK regulators are questioning the London Metal Exchange about what went wrong in the nickel market last month, but the exchange’s chief said the core problem lies in the trades he can’t see.

The LME has launched its own independent review, as has the Financial Conduct Authority and the Bank of England, which oversees its clearing house. The reviews follow a huge spike in nickel prices that caused the exchange to suspend trading in the metal for eight days, sparking deep anger at the LME’s handling of the event.

But the exchange said it didn’t know the huge scale of the nickel bet that sparked the disruption before the price erupted on large positions placed privately through banks. Without addressing the bets that can build up behind closed doors, the market is vulnerable to further shocks, he warned.

“It is absolutely right that we go and review all the activities so that we are satisfied that we can be accountable for everything that has happened,” LME chief executive Matthew Chamberlain said in an interview.

Nickel prices surged 250 percent ahead of March 8 when the LME halted contracts and canceled a day’s worth of trades after Russia’s invasion of Ukraine sparked fears of shortages in supplies of a metal vital to building electric vehicles is.

The rapid rally was a boon to traders betting on profits for nickel. But it shattered a bet by the Chinese metals magnate Xiangguangda that prices would fall.

The subsequent stopping and cancellation of transactions by the LME proved divisive for the exchange’s customers, as their efforts to protect smaller companies at risk of collapse wiped out profits from other traders. However, the question remains how the billionaire founder of China’s leading stainless steel producer Tsingshan Holding Group was able to build up such a huge, allegedly multi-billion dollar counterfeit position without the knowledge of the stock market and whether it took enough steps to protect itself and its users.

Valuers must navigate the complex interaction between commodity derivatives, which are privately negotiated and traded off-market, and futures traded on an exchange.

But they also need to tear apart a market in which the world’s 12 largest investment banks generated the bulk of the $6 billion in revenue in the first half of last year by selling derivatives and acting as brokers for loans, according to Coalition Greenwich.

Financial futures contracts that track interest rates and stocks exist for hedging investment portfolios and for pure speculation. But commodity futures were originally designed to allow for the mining, movement and storage of physical assets, and often involve contracts with quirky expirations or other bespoke features unsuitable for standardized exchanges. This leads to an opaque world with little information available to the public or even the exchanges they interact with.

People familiar with the matter say the LME knew Tsingshan had made some big bets on its exchange. However, she was unaware of a large number of similar deals the Chinese group had made through banks on a so-called over-the-counter basis. LME executives’ realization that this had enabled only about a fifth of the full short position was a key factor in the decision to halt trading.

Other exchanges are in a similar position. The head of regulation at an exchange that offers metals futures told the Financial Times he “can’t be sure” how much bigger the over-the-counter market is than his market. “We can’t say that. . . we really can’t.”

Chamberlain said the LME needs to see more of the market. “OTC transparency is so important that we need to introduce OTC reporting requirements for other metals,” he said. His previous efforts to encourage banks to do more reporting have yielded no results.

The blind spot in over-the-counter markets should be addressed by reforms following the 2007-09 global financial crisis.

Regulators have called for open derivatives positions to be backed by more margin, a form of insurance in case one party defaults in a deal. The amount tends to increase when markets are stressed.

But lawyers said not all over-the-counter commodity derivatives are covered by the rules. This leaves brokers the freedom to negotiate with their clients on the amount of margin they can raise. This is likely to be influenced in part by the broker’s view of the customer’s credit risk.

Brokers are wary of sharing information about their OTC trades with the LME, arguing that a market with enough margin to hedge the trades would be sufficient.

“That is none of the business of the LME. All the LME needs to know is whether the member has deposited sufficient initial margin,” wrote Mark Thompson, vice chairman of Tungsten West and a former LME trader, on Twitter.

Critics like Thompson have said that the BoE’s scrutiny of the LME clearing house, which sits between two parties in a trade to prevent defaults from rippling through the market, will offer the better answer to what will happen on June 8. March happened.

To reduce demands for millions of dollars in margins, LME Clear enables brokers to offset losses suffered by one client against another client’s profits. It also means that when a metal’s price moves wildly in unexpected ways, the broker must find the money to pay the winners.

Steven Spencer, a former metal trader and member of the LME’s arbitration board, said the risk has been exacerbated by the entry of electronic traders into a specialty market like nickel, who are more keen to profit from betting on the metal’s value and direction than it is in production to use.

Global supply is more limited than other metals like copper and aluminum, there are fewer traders and participants all use the same model to calculate their risk, he added.

“In a low-liquidity market like nickel, which is traded electronically overnight, the volume to be hedged can increase exponentially if the price moves violently,” he said.

The problem is further exacerbated because the LME clearing house, although open in the mornings in Asia, typically does not request an intraday margin call until the market opens at 8am London time.

But Thompson has questioned why the LME hasn’t dramatically increased its margin requirements over the past few days and weeks when it was known there was a very large short position in the nickel market and sanctions against Russia – where most Nickel is mined – this could raise the price. In the past this was the LME warned by regulators over shortcomings in market surveillance, he added.

On March 7th, nickel rose by $20,000 per tonne, but the starting margin was the equivalent of only $2,300 per tonne.

“Any sane person would have suspended the market and increased the margin to at least $20,000 a ton,” he said. “They would never have got into this situation if they had acted prudently.”

By March 8th the damage was done – nickel had risen to record levels.

This sparked the LME’s decision to cancel thousands of trades and caused an uproar among many customers. To restore that trust, regulators need to do thorough scrutiny.

Additional reporting by Neil Hume LME boss calls for a review of private deals in nickel probes

Adam Bradshaw

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