Reuters | June 9, 2022 |
Credit: LME
(The opinions expressed here are those of the author, Andy Home, a columnist for Reuters.)
The London Metal Exchange’s (LME) nickel nightmare continues.
US hedge fund Elliott Management and trading house Jane Street are suing the exchange for $456 million and $15.3 million respectively over its handling of the nickel market meltdown in March.
The LME suspended trading in its nickel contract at 0815 UK local time on March 8 after the price exploded to $101,365 per tonne. It also canceled all trades between midnight and the market halt.
A legal reaction from aggrieved long position holders was only to be expected. The LME and its owner Hong Kong Exchanges and Clearing (HKEx) have dismissed the claims and “will defend any judicial review proceedings vigorously”.
The legal action will be a lawyerly stress-test of the LME rule-book, particularly the definition of what constitutes an orderly market.
But this is about more than just money.
The cancellation of agreed trades has broken a cardinal market rule for many in the investment community. The LME and British regulators will have to persuade them it won’t ever happen again if they are to return.
Legal defenses
The LME’s legal defenses are at first sight formidable.
Its rule book grants the exchange wide-ranging powers to act in “emergencies”.
Those powers are exercised through the “Special Committee”, a body established to remove any conflict of interest from LME market interventions.
Chaired by Phillip Crowson, previously a long-standing LME director, the “specials” include LME chairwoman Gay Huey Evans, who also sits on the UK Treasury board, LME Clear board member Marco Strimer, arbitration lawyer Barbara Dohmann QC and independent LME director Dr. Herta Von Stiegel.
The Committee “may take such steps as in the absolute discretion they deem necessary to contain or rectify” any “undesirable” situation.
Moreover, in the event of “a significant price movement during a short period”, the LME can suspend trading and “may cancel, vary or correct any Agreed Trade or Contract.”
As always, the legal devil will be in the detail, for which we await the LME’s own promised “forensic” report into what happened in the lead-up to the events of March 8.
Order, disorder
“The LME has undermined confidence in its ability to oversee markets by failing to perform its regulatory obligations to maintain an orderly market,” according to the Managed Funds Association, which represents over 140 investment companies.
The LME, for its part, claims it was precisely because the nickel market had become “disorderly” that it took the action it did.
“It became clear that pricing in the early hours (of March 8) trading did not reflect the underlying physical market and that the Nickel market had become disorderly,” it said in a March 10 statement. As such, trades were canceled to take the price back to the last point at which the exchange “could be confident that the market was behaving in an orderly fashion”.
However, it is now clear the exchange acted also to avert what it perceived to be a systemic threat resulting from participants’ inability to meet margin calls on nickel’s explosive price move.
The LME said it “had serious concerns” that margin-call stress was “raising the significant risk of multiple defaults”.
A cascade of defaults from less-well capitalized member companies would have risked a repeat of the exchange’s near-death experience during the 1985 Tin Crisis.
The most disorderly market of all is one when half the players have just gone technically bust.
Cardinal sin
Many fund managers, however, will take a lot of convincing.
The LME’s decision to cancel trades was “utterly, incomprehensibly wrong”, Ken Griffin, chief executive of investment company Citadel told Bloomberg TV.
Griffin, who “didn’t have a meaningful position in nickel at all”, warned that “when you interfere with markets on an ex-post basis, it’s incredibly destructive to the meaning of markets”.
Jane Street seems to agree, telling the Financial Times that the damages sought are “secondary”. Rather, it wants to send a message that it would take action against any “unreasonable” behavior by an exchange.
The retroactive cancellation of trades for such like-minded free-market advocates amounts to a cardinal sin.
March 8 was “one of the worst days in my professional career in terms of watching the behavior of an exchange,” Griffin said.
Free markets
The irony is that the LME has always prided itself on being a free-market bastion of light-touch regulation, eschewing position limits, circuit-breakers or fixed lending caps.
The 145-year-old exchange is the epitome of London’s traditional laissez-faire approach to professional, wholesale trading venues.
The LME’s rule book was written by Alan Whiting, who was parachuted into the exchange from the U.K. Treasury to clean up the aftermath of the Sumitomo copper fiasco of the 1990s.
The danger of such a hands-off approach, however, is that a market may turn so wild that regulators are left behind the curve in trying to tame it.
Whiting himself conceded that one of the strongest arguments for automatic intervention “is the difficulty in analyzing and assessing the reasons for and causes of the backwardation or unusual price movements”. (“Market Aberrations – The Way Forward”, 1998)
Any discretionary intervention by an exchange “may, inadvertently, be mistaken and inappropriate” and even when “correct” will always be “contentious because there will always be parties who will consider themselves to have been financially disadvantaged.”
Prescient words but the LME decided against automatic market constraints at the time and the London trading community has resisted them ever since.
They are now in place across all the LME’s physically-deliverable contracts and keeping them will be a minimum requirement for many funds.
The key, according to Citadel’s Griffin, is the “necessity of clarity on exchange rules”.
The days of the LME’s resistance to pre-emptive, automatic market intervention look numbered. Indeed, they may already be over.
What’s not in doubt is the urgency of repairing the regulatory system that resulted in the May mayhem.
Griffin predicted a shift in liquidity to other venues and “you’ll see people drop out of markets”.
It’s already happening.
LME nickel trading volumes fell by 35% year-on-year in May, part of a broader 13% decline in trading activity last month.
And Britannia Global Markets has just announced its intention to relinquish its clearing membership of the LME, citing “a clear hesitancy of some participants to support the existing LME market structure.”
It will continue to trade metals but on an over-the-counter basis, a warning sign that liquidity is already on the move away from the exchange.
(Editing by David Evans)
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