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LME chief calls for scrutiny of private deals in nickel probes

UK regulators are asking the London Metal Exchange about what went wrong in the nickel market last month, but the exchange’s chief said the main problem lies with trades he cannot see.

The LME has launched its own independent review, as have the Financial Conduct Authority and the Bank of England, which oversees its clearing house. The criticism follows a huge spike in nickel prices that led to the exchange suspending trading in the metal for eight days, sparking deep anger over the LME’s handling of the event.

But the exchange said it did not know the scale of the nickel bet that sparked the disruption before the price erupted due to large positions placed privately through banks. Without addressing bets that can pile up behind closed doors, the market is vulnerable to further shocks, he warned.

“It is only right that we review all activity so that we are happy that we can report on everything that has happened, LME chief executive Matthew Chamberlain said in an interview.

The price of nickel rose 250% ahead of March 8, when the LME halted contracts and wiped out a day of trading after Russia’s invasion of Ukraine sparked fears of a supply shortage for a metal crucial for the construction of electric vehicles.

The rapid rally was a boon for traders who had been betting on the nickel’s gains. But it crushed a bet by Chinese metals tycoon Xiang Guangda that prices would plummet.

The LME’s subsequent halt and cancellation of trades proved divisive for the exchange’s clients, as its efforts to protect small businesses threatened with collapse wiped out the profits of other traders. But there remain unanswered questions as to how the billionaire founder of China’s leading stainless steel producer, Tsingshan Holding Group, was able to build up such a huge position the wrong way – believed to be worth billions – without that the exchange knows about it and whether it has taken sufficient action. to protect itself and its users.

Examiners will need to navigate the complex interplay between commodity derivatives that are privately traded and traded off-market and futures contracts traded on an exchange.

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

Financial futures on interest rates and equities exist for investment portfolio hedging and for outright speculation. But commodity futures contracts were originally constructed to accommodate the extraction, movement and storage of physical assets and often involve contracts with odd maturities or other unsuitable bespoke characteristics. standardized exchanges. This creates an opaque world with little information available to the public or even to the exchanges they interact with.

People familiar with the matter say the LME knew Tsingshan had taken big bets on his trade. But he was unaware of a large number of similar deals the Chinese group had done through banks on a so-called over-the-counter basis. The realization by LME executives that it had facilitated only about a fifth of the short seller’s full position was a crucial factor in the decision to halt trading.

Other exchanges are in a similar position. The head of regulation for an exchange offering metals futures told the Financial Times that he “couldn’t be sure” of the size of the off-exchange market relative to his market. “We can’t say. . . we really can’t.

Chamberlain said the LME needed to see more of the market. “OTC transparency is important enough that we need to impose OTC reporting requirements on other metals,” he said. Its earlier efforts to encourage more reporting by banks have not yielded results.

The blind spot in OTC markets needed to be addressed through reforms after the 2007-09 global financial crisis.

Regulators have required open positions in derivatives to be backed by a larger margin, a form of insurance if one party to a transaction defaults. The amount generally increases when the markets are stressed.

But lawyers said not all OTC derivatives were covered by the rules. This leaves brokers free to negotiate with their clients how much margin to accumulate. This is likely to be influenced in part by the broker’s view of the client’s credit risk.

Brokers are reluctant to report information to the LME about their OTC trades and argue that a market with enough margin to support trades would suffice.

“It’s none of the LME’s business. All the LME needs to know is that the member posted sufficient initial margin, wrote Mark Thompson, VP of Tungsten West and former LME trader, on Twitter.

Critics like Thompson said the BoE’s review of the LME clearing house, which sits between two parties in a transaction to help prevent defaults from spreading to the market, will offer the best answer to what happened on March 8.

To help reduce demands for millions of dollars of margin, LME Clear allows brokers to offset one client’s losses against another client’s profits. It also means that if the price of a metal unexpectedly moves violently, the broker must find the money to pay out the winners.

Steven Spencer, a former metals trader and member of the LME’s arbitration panel, said the risk was exacerbated by the arrival in a specialist market like nickel of electronic traders, who are looking to profit from value bets. and the direction of the metal rather than using it in manufacturing.

The global supply was more limited than other metals like 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 trades electronically overnight, the volume that needs to be hedged can increase exponentially as the price moves violently,” he said.

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

But Thompson wondered why the LME hadn’t dramatically increased its margin requirements over the previous days and weeks, when it was well known that there was a very large short position in the nickel market and that sanctions against Russia – where most of the nickel is mined – could increase the price. In the past, the LME had been warned by regulators about shortcomings in its market oversight, he added.

On March 7, nickel was up $20,000 per ton but the initial margin was the equivalent of only $2,300 per ton.

“Any sane person would have suspended 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 with caution.”

By March 8, the damage was done – nickel had reached record highs.

This triggered the LME’s decision to rollback thousands of transactions and caused an outcry among many customers. To restore that trust, regulator reviews will need to be thorough.

Additional reporting by Neil Hume