LME chief calls for investigation of private deals in nickel probes



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UK regulators are polling the London Metal Exchange about what went wrong in the nickel market last month, but the exchange chief has said the core problem lies with the transactions he can’t see.

The LME has launched its own independent review, as have the Financial Conduct Authority and the Bank of England, which oversee its clearinghouse. The reviews follow a massive spike in nickel prices that prompted the exchange to suspend trading in the metal for eight days, sparking deep anger at the LME’s handling of the event.

But the exchange said it was unaware of the sheer magnitude of the nickel bet that caused the disruption before the price broke out due to large positions placed privately through banks. Without addressing the bets that can arise behind closed doors, the market is vulnerable to further shocks, it warned.

“It’s absolutely right that we’re going to look at all the activity so we can make sure we can explain everything that happened,” Matthew Chamberlain, chief executive of the LME, said in an interview.

The price of nickel rose 250 percent leading up to March 8, when the LME cut contracts and wiped out a day’s worth of transactions after Russia’s invasion of Ukraine sparked fears over supply shortages for a metal critical to electric vehicle construction. .

The rapid rally was a boon to traders who had been betting on nickel gains. But it crushed a bet by Chinese metal magnate Xiang Guangda that prices would fall.

The LME’s subsequent halting and canceling of trades proved divisive to the exchange’s clients, as its efforts to protect smaller companies at risk of collapse wiped out profits for other traders. But there are unanswered questions about how the billionaire founder of China’s leading stainless steel producer Tsingshan Holding Group could have built such a huge misplaced position — reportedly worth billions — without the stock market knowing and whether it had taken enough steps to protect itself and protect its users.

Reviewers will have to navigate the complex interaction between commodity derivatives that are privately negotiated and traded off-market, and futures that are traded on an exchange.

But they will also have to break into a market where the world’s 12 largest investment banks made the bulk of $6 billion in revenue in the first half of last year by selling derivatives and acting as credit intermediaries, according to Coalition Greenwich.

Financial futures exist that track interest rates and stocks for hedging investment portfolios and for outright speculation. But commodities futures were originally built to allow for the mining, movement and storage of physical assets and often include contracts with idiosyncratic maturities or other custom features unsuitable for standardized exchanges. That makes for an opaque world with little information available to the public or even the exchanges they interact with.

People familiar with the case say the LME knew that Tsingshan had taken some large bets on his purse. But it was not aware of a large number of similar transactions that the Chinese group had concluded through banks on a so-called over-the-counter basis. LME executives’ realization that it had facilitated only about one-fifth of the short seller’s entire position was a critical factor in the decision to stop trading.

Other exchanges are in a similar position. The head of regulation at an exchange that offers metal futures told the Financial Times he was “unsure” how much larger the off-exchange market was than his market. “We can’t tell. † † we really can’t.”

Chamberlain said the LME needed to see more of the market. “OTC transparency is so important that we need to set OTC reporting requirements for other metals,” he said. His previous efforts to encourage more reporting by banks were unsuccessful.

The blind spot in the over-the-counter markets is said to have been resolved by reforms following the global financial crisis of 2007-09.

Regulators demanded that open derivative positions be covered by more margin, a form of insurance if a party to a deal defaults. The amount usually rises when markets are stressed.

But lawyers said not all over-the-counter commodity derivatives were covered by the rules. That leaves brokers free to negotiate with their clients on the amount of margin to increase. This is probably partly colored by the broker’s view of the customer’s credit risk.

Brokers are wary of handing over information about their OTC deals to the LME, stating that a market with enough margin to support the trades would be sufficient.

“This is not the LME’s business. All the LME needs to know is that the member has booked sufficient initial margin,” Tungsten West Vice President Mark Thompson and former LME trader wrote on Twitter.

Critics like Thompson have said the BoE’s review of the LME’s clearinghouse, which is in a deal between the two parties to prevent defaults from rippling through the market, will provide the better response to what happened on March 8.

To help reduce the demand for multimillion-dollar margin demand, LME Clear allows brokers to offset the losses suffered by one client against the profits of another client. It also means that if the price of a metal moves violently in unexpected ways, the broker must find the money to pay the winners.

Steven Spencer, a former metals trader and member of the LME’s arbitration panel, said the risk was compounded by the advent of a specialty market like nickel from electronic traders, who want to take advantage of betting on the metal’s value and direction rather than than to use it in production.

Global supply was more limited than other metals such as copper and aluminum, there were fewer traders and participants all used the same model to calculate their risk, he added.

“In a low-liquidity market like nickel, which is traded electronically overnight, the volume to be hedged can increase exponentially as the price moves violently,” he said.

The problem is further exacerbated because, although it opens in the morning in Asia, LME’s clearing house does not typically request an intraday margin call until the market opens at 8 a.m. London time.

But Thompson has questioned why the LME hadn’t drastically increased margin requirements in the preceding days and weeks, when it was widely known that the nickel market was very short and sanctions against Russia – where most nickel is mined – could be possible. raise the price. In the past, the LME had been warned by regulators about market oversight failures, he added.

On March 7, the nickel price rose by $20,000 per tonne, but the initial margin was only $2,300 per tonne.

“Any sane person would have shut down the market and increased the margin to at least $20,000 a ton,” he said. “They would never have been in this position if they had acted cautiously.”

By March 8, the damage was done: nickel had risen to an all-time high.

This led to the LME’s decision to cancel thousands of transactions and caused a stir among many customers. To restore that confidence, the assessments by the regulators will have to be thorough.

Additional reporting by Neil Hume

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