The London Metal Exchange angered some of the world’s most influential electronic traders after it closed its nickel market and canceled thousands of deals in response to a surge in the metal’s price.
Months after the 145-year-old exchange upset its traditional users by considering an end to raucous in-person trading, the LME this week closed its nickel trading, a market where it sets global benchmarks, in a move last seen. once in tin in 1985.
The crisis move came after the value of the metal more than doubled in two days to a record over $100,000 a tonne as a big bet against the price of nickel left the tycoon behind Tsingshan Holding Group. , China’s leading stainless steel group, facing billions of dollars in potential losses.
But the exchange also canceled all 5,000 nickel deals that had taken place on Tuesday, worth nearly $4 billion. Mark Thompson, vice president of Tungsten West and a longtime trader on the LME, estimated that the exchange had wiped out $1.3 billion of profit and loss on the deals. It 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 crossed a line. The LME not only failed to manage the risks, but also chose a side when it should be neutral, they say.
AQR, one of the world’s largest hedge funds, is exploring legal options in its dispute with the LME after losing significant profits from the bourse’s decision, according to people familiar with the matter.
In a series of posts on Twitter, Clifford Asness, founder of the $140bn fund, described the LME as “slime balls”. This was, he said, the first time he was told “you don’t get your legitimate profits because, gosh, someone else, a broker who didn’t handle things so well, could suffer.”
I am accusing you [the LME] of reversing trades to save your favorite cronies and steal from your non-crony clients,” he continued. The LME denied that parent company Hong Kong Exchanges and Clearing had influenced his decision.
The exchange is in talks with its regulator, the Financial Conduct Authority, and with the Prudential Regulation Authority, which oversees its clearing house. Regulators declined to comment on the matter.
The accusation of favoritism can be difficult to change. The issue has touched an all too familiar dividing line for the LME, between those members who trade on behalf of users who want to buy the physical product for use in manufacturing, and e-merchants, who seek to profit from successful bets on the value and address of the product.
The cancellation of operations had been necessary because the size of the short position that had been accumulated in the nickel rocket presented a systemic risk, said Matt Chamberlain, executive director of the LME.
“One of our key responsibilities is serving physical merchants,” he said. “If we were to allow trading to continue, we would have to say that the nickel price is $80,000 to $90,000 and that would not seem rational for the physical market. And we could have put significant pressure on a number of our core members.”
Last year, Chamberlain was thwarted in his plans to close the floor and make the market fully electronic, after strong opposition from merchants and industrial users. Now it’s the e-merchants who are in an uproar. Alex Gerko, co-CEO of electronic market maker XTX Markets, called it the “Soviet Metals Exchange.”
“It’s potentially very damaging to your reputation. It is electronic versus physical. What it reflects is that the mindset of the LME is to protect the old men’s club rather than the larger growing financial community,” said a former senior executive involved with the LME.
Organizations behind the scenes of trading have the right to close deals, although this is rarely used.
Clearinghouses manage the risks that can accumulate when traders’ bets are too large and get in between trades to prevent defaults from spreading throughout the market. In this case, the LME clearinghouse had the right to shut down the tycoon’s trades if he couldn’t pay the margin to back them, said Athanassios Diplas of Diplas Advisors, a former credit risk manager at Deutsche Bank.
The exchange also has a “predetermined waterfall” of financial resources that can be called upon when the crisis hits, he said. “The first party that is supposed to be affected is the defaulting party, before everyone else,” he said. “That is not what is happening here.”
Part of the problem is that Tsingshan’s position was so large and held mostly in non-exchange-traded derivatives, taken out with multiple banks, according to a person familiar with the matter. The exchange saw only a fifth of the full position and realized the full scale only this week when banks revealed their holdings. It would be up to Tsingshan brokers, sitting on potentially massive trading losses, to close those positions off-exchange.
“We are now focused on the mechanics of reopening the market as efficiently and quickly as possible,” the LME said in a statement on Friday.
Untangling the knot to satisfy all of its members may be beyond sharing and it faces a battle to reestablish trust with its electronic users, Chamberlain acknowledges.
“We have a job to rebuild our reputation with that segment of the market. I think this offers us an opportunity 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 has pushed as chief executive but has been resisted by banks. The LME has also imposed some emergency measures, including a 10 percent limit on nickel movements.
The exchange has a dominant global share of commodities such as aluminium, copper, nickel and zinc, ahead of CME Group, the Chicago futures exchange.
Nickel is expected to be a battlefield of the future because it is used in electric vehicles. For now, the CME does not have a nickel futures contract, but the LME stumbles may prompt a rethink, prompted by frustrated traders.
“These things don’t happen overnight and it’s not easy to change liquidity. But yeah, we would definitely support that,” said Yao Hua Ooi, co-head of AQR’s macro strategies group.
“If they [the LME] lose the position they have in this metal, the growth opportunities of the LME are going to be quite dire”, said the former executive. “If they don’t react, the CME will eat their lunch and the price benchmark will move away from London.”