Thursday, September 29 2022

The London Metal Exchange has angered some of the world’s most influential electronic traders after shutting down its nickel market and canceling thousands of trades in response to a spike in the metal’s price.

Months after the 145-year-old exchange upset its traditional users by considering ending noisy in-person trading, the LME closed its nickel trade – a market where it sets global benchmarks – this week in a move seen for last seen in the tin in 1985.

The crisis measure came after the metal’s value more than doubled in two days, to a record above $100,000 a ton, as a big bet against the price of nickel left the tycoon behind Tsingshan Holding Group, China’s leading stainless steel group, faces billions of dollars in potential losses.

But the exchange also canceled the 5,000 nickel trades that had been executed on Tuesday, worth nearly $4 billion. Mark Thompson, vice chairman of Tungsten West and a longtime LME trader, estimated the exchange wiped out $1.3 billion in trading profits and losses. This was “in the interest of the market as a whole”, the LME said.

Some market participants say that by effectively erasing the day from the record books, the exchange has crossed a line. Not only did the LME fail to manage the risks, but it also chose a side when it should be neutral, they say.

The nearly 150-year-old LME angered its traditional users last year by considering ending noisy in-person transactions. He eventually reversed course on the plans. ©Bloomberg

AQR, one of the world’s largest hedge funds, is exploring legal options in its dispute with the LME after losing significant profits following the exchange’s decision, according to people familiar with the matter.

In a series of Twitter posts, Clifford Asness, founder of the $140 billion fund, described the LME as “balls of drool”. It was, he says, the first time he was told “you’re not getting your legitimate profits because, damn it, someone else, a broker who didn’t handle things so well. , could suffer from it”.

“I accuse you [the LME] reverse transactions to save your favorite friends and rob your non-friend customers,” he continued. The LME denied that parent company Hong Kong Exchanges and Clearing influenced its decision.

The exchange is in talks with its regulator, the Financial Conduct Authority, and with the Prudential Regulation Authority, which oversees its clearinghouse. Regulators declined to comment on the matter.

The accusation of favoritism can be difficult to overturn. The issue has reached an all-too-familiar fault line at the LME, between members who trade on behalf of users wishing to purchase the physical product for use in manufacturing, and e-traders, who seek to profit from successful bets on the value and direction of the product.

The cancellation of the trades was necessary because the size of the short position that had been accumulated in the surge in nickel posed a systemic risk, said Matt Chamberlain, chief executive of LME.

“One of our main responsibilities is to serve physical merchants,” he said. “If we let the trades hold, we would have to say that the price of nickel is $80,000 to $90,000 and that would not seem rational for the physical market. And we could have put a lot of stress on a number of our core members.

Last year Chamberlain was frustrated in its plans to shut down the dealing room and make the market fully electronic, after fierce opposition from traders and industrial users. Now it’s the e-tailers who are getting emotional. Alex Gerko, co-CEO of electronic market maker XTX Markets, called it the “Soviet Metal Exchange”.

“It is potentially very damaging to his reputation. It’s electronic versus physical. What this reflects is that the mentality of the LME is to protect the old boys’ club as opposed to the growing financial community,” said a former senior executive involved with the LME.

Organizations behind the trading scenes have the right to close trades, although this is rarely used.

Line chart of LME benchmark nickel contract price ($/tonne) showing nickel hitting all-time high

Clearinghouses manage the risks that can build up when traders’ bets get too big and hold between trades to prevent defaults from spreading through the market. In this case, the LME clearinghouse had the right to close the tycoon’s trades if he couldn’t pay the margin to back them, said Athanassios Diplas of Diplas Advisors, a former head of credit risk at Deutsche Bank. .

The exchange also has a “default cascade” of financial resources that can be drawn on in a crisis, he said. “The first part that is supposed to be impacted is the failing part, before anyone else,” he said. “That’s not what’s happening here.”

Part of the problem is that Tsingshan’s position was so large and mostly held in derivatives that are not exchange-traded, underwritten by multiple banks, according to a person familiar with the matter. The stock market saw only a fifth of the total position and only realized the magnitude this week when banks disclosed their holdings. It would be up to Tsingshan brokers, sitting on potentially massive trading losses, to close those off-exchange positions.

“We are now focusing on mechanisms to reopen the market as efficiently and as quickly as possible,” the LME said in a statement on Friday.

Untangling the knot to satisfy all of its members may be beyond the exchange and it faces a battle to rebuild trust with its electronic users, Chamberlain acknowledges.

“We have a job to rebuild our reputation with this segment of the market. Where I think this gives us the opportunity is to finally put in place the market protections that we need,” he said.

Those protections could include greater disclosure of clients’ off-exchange positions — a move Chamberlain pushed as chief executive but the banks resisted. The LME also imposed emergency measures, including a 10% cap on nickel transfers.

The exchange holds a dominant global share of commodities such as aluminum, copper, nickel and zinc, ahead of CME Group, the Chicago futures exchange.

Nickel should be a battleground of the future as it is used in electric vehicles. For now, the CME does not have a nickel futures contract, but the LME’s stumble may prompt a rethink, prompted by frustrated traders.

“These things don’t happen overnight and it’s not easy to transfer cash. But yes, we would definitely support that,” said Yao Hua Ooi, Co-Head of Macro Strategies Group at AQR.

“If they [the LME] lose the position they have in this metal, the LME’s growth opportunities are going to be pretty dire,” the former executive said. “If they don’t react, the CME will eat its lunch and the price benchmark will move away from London.”

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