LME’s Nickel review shows how exchange failed to prevent crisis

The report, which was commissioned by the LME and carried out by consultancy Oliver Wyman, marks the start of what’s likely to be a year of reckoning for the exchange, as it faces regulatory investigations, lawsuits and a battle to rebuild faith in its contracts.

The report left many key questions unanswered by design. It avoided passing judgment on the LME’s most controversial decisions – allowing the market to reopen on March 8, then suspending it and canceling billions of dollars of trades — which are at the heart of the lawsuits brought by Elliott Investment Management and Jane Street against the LME.

And, while Oliver Wyman conducted a forensic review of trading in the nickel market, the public report did not go into detail on whether it found any manipulative behavior.

But the report did describe a string of shortcomings at the LME in the run-up to March 8, when prices soared to a record high above $100,000 a ton, up 270% in just three trading days — the result of a short squeeze the report described as “unprecedented in a major commodity in recent times” and compared to the Hunt brothers’ attempt to corner the silver market in 1980.

It also made a string of 27 recommendations to strengthen the LME’s rules and procedures, including toughening oversight of the over-the-counter market, introducing harsher position limits, and strengthening requirements for clearing members.  

“We recognize that there are clear lessons to learn from March,” Matthew Chamberlain, the LME’s chief executive officer, said in an interview. “We now have a real road map for things we can do to try to rebuild confidence in the market.”

He said the LME had no fundamental disagreements with any of the recommendations, and would publish an action plan by the end of March. It will start implementing some changes as soon as the plan is published, with others coming later this year after a consultation period, and some requiring changes to trading systems that might take 18 to 24 months.

Most striking of the shortcomings identified in the report was the LME’s failure to understand and police the large positions in the nickel market. The report didn’t name any individual market participants, but noted that Bloomberg reported several weeks before the crisis that Tsingshan Holding Group Co. had a large short position in LME nickel. Bloomberg subsequently reported that the Chinese company’s inability to meet margin calls was at the center of the short squeeze.

In part, the LME failed to spot the risk because much of Tsingshan’s position was held in the OTC market, which the exchange doesn’t control or oversee. 

“LME Group management stated that when risks around specific large positions were evaluated, the presence of a large on-exchange component created an impression that it constituted the entirety of that beneficial owner’s position when in fact there was a larger position held OTC,” the report said.

The report revealed that as banks and brokers were making unprecedented margin payments to the exchange, their clients were missing billions of dollars in margin calls on their OTC contracts. Two clients accounted for more than $2 billion of missed OTC margin calls.

Since the crisis, the LME has introduced rules forcing members to report details of their OTC positions. Still, the report called on the LME and regulators like the Financial Conduct Authority to work on additional ways to reduce risks in the OTC market.

The exchange also failed to use the tools it did have to oversee the big positions in the market. While the LME sets “accountability levels,” above which a trader can be asked to explain and justify their position, it focused its inquiries on attempted corners of specific delivery dates, rather than large positions – like Tsingshan’s – that were spread across multiple delivery dates.

“Systematically and thoroughly following up on net accountability level excesses could have allowed the LME to identify significant OTC exposures being run by multiple members,” the report said. As a result, it recommended introducing position limits at levels that make them “effective protection against speculative positions causing extreme price fluctuations.” (There are already position limits on the LME, but they’re so permissive as to be almost meaningless.)

What’s more, the report said that the LME’s controls on price volatility were insufficient. The exchange did not have trading limits or circuit breakers in place at the time of the crisis, though it has since introduced a 15% daily price limit.

It also took aim at the LME’s clearinghouse, arguing that the composition of its membership – including numerous small brokers specializing in the LME – “can give the perception that the clearing system is less robust than elsewhere.” As a result, LME Clear should enhance safeguards around member composition, potentially including increasing minimum capital requirements and imposing stricter risk management controls.

“The independent review has confirmed our concerns that the LME lacked the systems and controls to manage through the March 2022 nickel crisis,” said Jennifer Han, head of global regulatory affairs at the Managed Funds Association. “LME failed to maintain an orderly market, manage conflicts of interest, and protect investors in the nickel market and must institute controls so market participants can engage in these markets with confidence.”

This story has been published from a wire agency feed without modifications to the text.