An independent review has recommended the London Metal Exchange (LME) tighten its rules to improve its ability to identify and prevent future market distortions similar to those that triggered a chaotic period in the nickel market last year and prompted lawsuits from investors.
The Hong Kong Exchanges and Clearing (HKEX)-owned bourse said it was “committed to taking all the necessary steps” to rebuild public confidence in its metals market, and would unveil an implementation plan in response to recommendations by consultant Oliver Wyman by the end of the first quarter.
“This will allow for careful consideration of each of the recommendations, and appropriate methods to implement them,” LME CEO Matthew Chamberlain said in a statement.
The LME, which is facing a separate review by British financial regulators in the matter, appointed Oliver Wyman in June to conduct an independent review into the events that forced the bourse to halt trading in nickel and cancel thousands of trades in the early hours of March 8 as soaring prices threatened to destabilise the market.
It was only the second time in the 146-year-old bourse’s history that it had cancelled trades in one of its metals. Nickel trading was halted for more than a week and had a chaotic restart.
Nickel prices, alongside other commodities, rose dramatically in early March after Russia’s invasion of Ukraine stoked concerns about supply shortages. Prices surged by as much as 250 per cent in just over 24 hours, squeezing dozens of short-sellers, including the world’s largest stainless steel producer, Tsingshan Holding Group of China.
The bourse has said the nickel market had become “disorderly” in the early hours of March 8 and the decision was made to cancel trades in order “to take the market back to the last point in time at which the LME could be confident that the market was operating in an orderly way”.
However, that decision has been criticised by some traders, who have said the exchange favoured some investors over others by cancelling completed trades that day.
US hedge fund Elliott Management and quantitative investing firm Jane Street Global Trading have sued the exchange in London, seeking up to £471 million (US$572 million) in damages.
In its report, Oliver Wyman said the LME should extend the mandate of its risk and control functions to “explicitly cover the identification and prevention of market distortions”.
The bourse’s rules and enforcement processes should be tightened to prevent risks of market distortions, such as adopting LME-specific position limits and revamping its existing accountability level framework to help address risks created by large positions, the report said.
The LME should also monitor “significant risks” in the over-the-counter (OTC) market to manage risks of market distortions. These could include measures requiring members to notify the LME when client positions reach set materiality thresholds, or when clients miss significant margin calls, the report said.
The bourse should also upgrade its volatility controls to slow down extreme price moves and build the market’s operational readiness to deal with extreme events, including developing processes for members to effectively manage client defaults on OTC and centrally cleared positions.
Chamberlain, the LME CEO, has pointed to the lack of transparency in off-exchange positions as one reason the bourse struggled to identify and manage the situation.
“The independent review has confirmed our concerns that the LME lacked the systems and controls to manage through the March 2022 nickel crisis, but it is essential that a robust regulatory review addresses how LME failed in its regulatory function,” said Jennifer Han, head of global regulatory affairs at the Managed Funds Association (MFA), a trade body representing some of the world’s biggest hedge funds.
The MFA filed a formal complaint with the LME in June over the bourse’s handling of the nickel situation.
The LME has already introduced a series of measures to try to avoid similar situations in the future, including upper and lower daily price limits for contracts that require metals to be physically delivered when a futures contract expires.
Last summer, the LME began requiring its members to report their OTC positions on a weekly basis for these metals, including contracts for aluminium, copper, nickel, tin and zinc.