Lucky nickel, LME?

It seems to me that the LME have dodged the bullet - or at least got away with no more than a minor scratch. The Financial Conduct Authority has just published its findings concerning the issues surrounding the nickel market in March 2022. The bottom line is a fine for the LME of £9.2 million.That may sound a lot, but considering that the trades that were cancelled on that fateful morning amounted to something in the order of $13 billion, one could argue that it’s more like a drop in the ocean. Add to that the fact that the judge had previously decided that the civil actions for damages from some of the parties to those contracts would be dismissed, and perhaps you can see what I mean.

Now, I’m sure the LME management would not be terribly keen on former traders telling them how to run their business, but nevertheless there are some questions that can reasonably be asked. Nickel became an LME metal in 1979/80, and has enjoyed a varied time. In the early days, the major producers were extremely reluctant to admit to using the market; in one case, LME contracts had to be sent to the Treasurer’s home address, elsewhere counterparty names were effectively artificial, to keep the parent name away from LME paperwork. Bit by bit, though, it all became respectable and regularised. One thing that was consistent was that the production of the Russian mining company Norilsk Nickel was effectively the world’s swing tonnage and enabled the LME contract to work - in crude terms, without Norilsk metal the ability of the LME to act as the global price-discovery forum would have been severely compromised. This was the case through Soviet and post-Soviet times, and regardless of the various changes of ownership undergone by a variety of nickel producers.

Russia started its war in Ukraine back in 2014, with the fighting in the Donbas and then Crimea; at that point, the direct effect on metals was not extreme. However, in the late autumn of 2021 and early winter of 2022, the noise was getting deafening; you didn’t nave to be a foreign affairs specialist to understand that Putin had his sights firmly set on a re-integration of Ukraine into Russia, which would only be possible through all-out war. That’s when the alarm bells should have started ringing, and prudence should have encouraged the LME to mark nickel initial margin rates up - and up and up and up, just as a protection in case the west at some point imposed sanctions on Russian metals as a result of an invasion and ground war actually starting.

Instead, what happened was some minor tinkering with margins, and a period of doing not much else, then watching the price explode, closing the market and then retrospectively cancelling trades entered into in good faith by consenting counterparties. I know that is a bit simplified, but the full timeline of the concluding period can be found in the FCA report.

There were of course other factors, most notably that some of the large short position was built up OTC, rather than on exchange, thus - to be fair - making it more difficult to see the full extent of the position. However, I would also point out that the existence of a very large short was broadly accepted within the business. What one doesn’t know is the detail of the margin requirement (or the size of the credit facility) between the end customer and the bank granting that facility.

So why do I say the LME has been lucky? Well, they seem to have ignored the ever-louder war drums coming from Moscow, to have paid insufficient heed to general market talk of the size of the short position, and finally to have committed a serious blunder in cancelling legitimate trades. I suspect that some of the lawsuits may be coming back to haunt them again; somebody is probably preparing another bullet that may be harder to dodge now.