Behind the Nickel Mess on the London Metal Exchange

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Stock exchanges sometimes halt trades or very occasionally cancel trades when technological glitches or “fat finger” errors cause one-time errors. But it’s rare that entire sessions are canceled after the fact, or that days are taken to allow trading to resume freely. Yet that is what happened with one of the oldest financial institutions, the London Metal Exchange, or LME. Russia’s invasion of Ukraine triggered a period of chaos in the nickel market, exposing vulnerabilities in the exchange. The incident sparked a push for more transparency in one of the darkest corners of financial markets.

1. Why such a focus on the LME?

It sets global benchmark prices for critical metals such as copper and aluminum, trading around $60 billion worth of futures contracts per day, more than half of the global total. The story dates back to the early 19th century, when traders would gather around a circle drawn in sawdust on the floor of the Jerusalem Cafe in the City of London. Today, in addition to its electronic market, the LME is one of the last exchanges with an open-outcry trading room, known as the “Ring”, where brokers shout orders to each other. It brings together mining companies, which use the LME to offset price risk, and hedge funds, which use it to speculate. Contracts are backed by physical metal held in a network of LME warehouses around the world, which maintains a direct link to real-world industry. In 2012, the LME was purchased by Hong Kong Exchanges and Clearing Ltd.

The price of nickel soared 250% in just over 24 hours, prompting the exchange to suspend trading on March 8. The seeds of the crisis had been sown by a Chinese tycoon, Xiang Guangda and his closed company Tsingshan Holding Group Co., a dominant force in the global production of nickel and stainless steel. Tsingshan had shorted nickel – betting prices would fall – because Xiang expected a rapid increase in production from new factories in Indonesia. Then came the February 24 invasion by Russia, which exports about 5% of the world’s nickel. A jump in price triggered a “short squeeze” – a term for what can happen to traders who bet on a falling price as it rises instead. In order to stop losses, short sellers quickly buy back the securities they used to make their bets, thus accelerating the rise in prices.

It decided to cancel $3.9 billion in trades, bringing the market back to the March 7 closing price of $48,078 per metric ton from a high of more than $100,000. Matthew Chamberlain, chief executive of the LME, said prices were “becoming disconnected” from “physical reality”. The move saved brokers pushed to the brink by margin calls, while serving as a bailout for Tsingshan and its banks. It also wiped out huge profits from investors who held bullish bets. It was not the first time that the LME had intervened. Guarantees were introduced following the ‘tin crisis’ of 1985, when a cartel of producers collapsed, and after a copper trading scandal at the Japanese trading house Sumitomo Corp. in 1996.

4. Why a wider impact?

Nickel trading was halted for a week to give participants – including Xiang – time to get their funding in order. When it resumed, the first three days produced short sessions hampered by technical issues and a new daily limit of 15% for price movements. Furious investors have vowed to walk away from the exchange, saying it has undermined confidence. Volatility and higher prices meant brokers needed more capital. Nickel trading volumes have fallen, raising concerns about further price swings. Paul Singer’s Elliott Investment Management has launched a $456 million claim, joined by other hedge funds seeking damages from the LME.

The crisis has thrust the LME into the global spotlight, with criticism ranging from the International Monetary Fund to Citadel Securities founder Ken Griffin. Nickel is the key ingredient in stainless steel used in everyday appliances, but it’s also essential for the transition from fossil fuels, as it’s used in the batteries carmakers need to electrify the fleet. global automobile. Attention has quickly turned to the risks lurking in the opaque corners of natural resource trading, including the vast ecosystem of privately-traded OTC derivative agreements that circumvent clearing house and market margin requirements. LME. Most large nickel short bets were in such trades, so the exchange failed to grasp the magnitude and potential systemic risk of the position. In May, he unveiled a plan to require members to report OTC positions.

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