This article was written by Martin Hates. All views and opinions expressed are strictly his own.
After the events of early-March, when the LME nickel market came close to being untradeable and price-unrepresentative, recent days have seen some sort of normality return to both business and prices, although the exchange is not out of the woods yet – cue a trio of wide-ranging external reviews.
The imposition of emergency price limit measures, which were progressively widened almost daily, did allow for a relatively fast re-start to trading after the March 8/March 16 suspension. Prices have now fallen back from the $100,000 per tonne high-water mark of the cancelled session, and at around the $32,000 level are now in line with both Shanghai and physical levels – albeit volumes were some 20% down in March.
This, then, is an apposite time to hold post-mortems on what happened, why it happened, who or what was at fault, lessons to be learnt, and what might need to change.
In no particular order, the FCA, the UK’s financial regulator will review the LME’s actions, while the Bank of England will examine LME Clear’s role. For good order, the LME itself has also commissioned an external review.
All of these investigations are timely and not a bad thing – it has been around a quarter of a century since the LME had a comprehensive root-and-branch examination and overhaul in the wake of the 1996 Sumitomo copper scandal.
Many of the measures brought in back then have largely stood the test of time – the lending guidance and warehousing reporting enhancements have not really changed too much over the last 25 years. Likewise, the large position and warrant holdings reports added another layer of transparency, but more recent attempts by the LME to get deeper visibility in the OTC sector have met opposition.
Crucially, it was the off-market OTC nickel position reportedly held by China’s Tsingshan and at that time invisible to LME Compliance, that was the fuel to the short-covering fire that enveloped the nickel market on March 7 and March 8. And once the price sky-rocketed in dangerously thin volumes, the market, by any description, was disorderly and unrepresentative.
In the run-up to the turmoil, the LME had taken some steps to try and calm the market – likewise most of its subsequent actions – halting trading, introducing daily limits, a shorter trading session and some monitoring of the OTC area are within its remit to maintain an orderly market.
It is worth remembering that the Exchange’s Special Committee was part of this process, and some of its members have decades of LME and metal industry experience. After the event, it is easy to say not enough was done, either before, during or just after the trading halt. In reality, LME authorities were in the midst of an unprecedented market meltdown and having to implement these measures at rapid speed.
Even so, there is an elephant in the room that may come back to haunt the LME in coming months and years – the cancellation of all the trades that took place on March 8. The justification was the likely size of the margin calls, which raised questions over the viability of some LME brokers.
That doesn’t sit well in capitalist free-markets, and litigation and lawsuits from hedge funds, who lost out on massive profits, are surely being prepared.
All of which will run their course as the reviews take place and make their judgments. Of these the LME’s independent review has the potential to usher in some significant changes to the way the exchange functions and trades in coming years.
Since the 2007/2008 financial crisis, politicians and regulators have sought greater insight into the OTC arena. Nickel in 2022 may provide the opportunity for wider oversight of off-market business in general. After all, what is manageable in equity ‘dark pools’ – the lack of visibility does not matter as the markets are massive – did not hold true for nickel.
Like tin, nickel is a small global market and liquidity is not great. So, the potential for an OTC position to cause the market to spiral out of control and become disorderly is much higher. Even the LME’s big contracts – copper and aluminium – are not immune to OTC upheavals. Thwarted last year, the LME may get its desire for OTC monitoring this time around.
Daily price fluctuation limits, too, may be here to stay. In an increasingly volatile and unpredictable geo-political and economic world, commodity markets will become more prone to vicious price spikes and collapses. Limit impositions will provide a necessary breathing space to prevent markets becoming disorderly.
Mandatory reductions of large positions, and increased margining are also worth considering, while the IT infrastructure could be enhanced.
All of which are for the not-too-distant future, when the LME will have a new CEO, and may be under new ownership. What seems certain is that the nickel crisis of 2022 will speed up the LME’s evolution away from its purist roots.
And that, for sure, will not be to everyone’s liking.
