It’s difficult to find fault with the Oliver Wyman report into the LME nickel debacle of last March; and, of course, there is no reason why one should want to find fault - after all, it’s in everybody’s interest that the market should function smoothly and efficiently, so anything that contributes to that must be a good thing. Quite rightly, the report considers the effect of large risk positions, the fragmentation of those positions between market and OTC books, the added risk of ‘hedging’ non-deliverable material and the overall particular sensitivity to geopolitical events faced by the nickel market (this last probably more relevant to nickel than any of the other main LME metals).
Reading through it, though, does make me begin to wonder if the LME is actually getting ever closer to a real fork in the road. The mythological god Janus looks both ways; is the LME trying to do the same?
Looking backwards - consider how it was. The LME was an adjunct to the physical metal business, offering a facility for hedging exposures to the volatile world of non-ferrous metal prices. Producers, consumers, traders - yes, and speculators - operating in a world where “my word is my bond” and by and large everybody knew everybody else. There were of course squeezes, scandals and bankruptcies aplenty, but the model soldiered on, serving the industry at its heart.
And then, looking forwards, what do we see? A seemingly ever-growing percentage of the market’s business coming from algos, HFTs and fund investors of various stripes, with the notionally still underlying metal business forming a smaller and smaller segment of the whole.
I talked above of a fork in the road, but in truth it’s probably more of a tipping point. Can one Exchange satisfy these two very different worlds? Oliver Wyman make some sensible recommendations about monitoring and understanding what is going on in the market and the wider geopolitical world, but is it not worth at least pondering whether the problem is not one to be solved by tinkering with the existing model, but rather what we should be thinking about is whether that model is any longer appropriate?
The present hybrid Ring doesn’t really seem terribly convincing, and the truth is that those for whom the date structure is a positive are becoming a smaller and smaller part of the whole. And why persist with the granting of credit to trade in an extremely volatile market? I think a rational person coming to the issue afresh would probably conclude that cash margining would be a far more secure environment.
The future for the LME looks as though it will be one of dozens of screens on the desks of the financial traders; it wouldn’t be my choice to see it that way, but it’s difficult to argue against it. In those circumstances, would it not make sense to consider whether making it look - in structure - like so many of those other financial markets should be the way forward? To introduce yet another metaphor to join the mythological god, the fork in the road and the tipping point, the dam may be holding at the moment, but for how long? Janus can look both ways at once, but he’s a god….