The London Metal Exchange has infuriated some of the world’s most powerful electronic traders after it closed its nickel market and canceled thousands of trades in response to the metal’s price spike.
Months after the 145-year-old exchange upset its traditional users by deciding to end raucous in-person transactions, the LME closed its trading in nickel this week – a market in which it sets global benchmarks – a move last seen in tin. in 1985.
The crisis measure came after the value of the metal more than doubled two days to a record $100,000 a tonne as a big bet on the price of nickel left the mogul behind Tsingshan Holding Group, China’s top stainless steel group facing billions dollars. potential losses.
But the exchange also canceled all 5,000 nickel trades that took place on Tuesday, worth nearly $4 billion. Mark Thompson, vice chairman of Tungsten West and longtime trader on the LME, estimated that the exchange lost $1.3 billion in profits and losses on trades. According to the LME, this was “in the interest of the market as a whole”.
Some market participants say that by effectively wiping the day off the record book, the exchange has crossed a line. The LME, they said, not only failed to manage the risks, but chose a side when it should have been neutral.
The nearly 150-year-old LME rattled its traditional users last year by deciding to put an end to noisy personal transactions. In the end, it changed course on plans. © Bloomberg
AQR, one of the largest hedge funds in the world, is exploring legal options in its dispute with the LME after losing significant profits due to the exchange’s decision, according to people familiar with the matter.
In a series of tweets, Clifford Asness, founder of the $140 billion fund, called the LME “goo balls.” According to him, this was the first time he was told: “You are not making a legitimate profit, because, God, someone else might get hurt, a broker who did not do things so well.”
“I blame you [the LME] canceling deals 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.
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The Exchange is negotiating 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 remove. The problem has run into a rift, all too familiar to the LME, between those members who trade on behalf of users who want to buy a physical commodity for use in manufacturing, and electronic traders who seek to profit from successful bets on the value and direction of a product.
The cancellation of trades was necessary because the size of the short position, which was filled with skyrocketing nickel, posed systemic risk, said Matt Chamberlain, chief executive of the LME.
“One of our key responsibilities is to serve physical traders,” he said. “If we let the trades stand, we would have to say that the nickel price is $80,000-$90,000, and that doesn’t seem rational for the physical market. And we could put a lot of pressure on a number of our core members.”
Last year, Chamberlain failed in his plans to close the trading floor and make the market fully electronic after strong resistance from traders and industrial users. Now it’s e-traders in the noise. Alex Gerko, one of the leaders of the electronic market maker XTX Markets, called it the “Soviet Metal Exchange”.
“This is potentially very damaging to his reputation. It’s electronic versus physical. This reflects that the LME mentality is protecting the old boys club rather than the broader growing financial community,” said a former LME-affiliated senior executive.
Organizations behind the scenes of trading have the power to close deals, although this is rarely used.
Clearing houses manage the risks that can arise when traders’ rates get too high and step in between trades to prevent defaults from spreading through the market. In this case, the LME clearing house had the right to close the tycoon’s trades if he failed to pay the margin to back them up, said Diplas Advisors’ Athanassios Diplas, a former credit risk manager at Deutsche Bank.
The exchange also has a “waterfall” of default financial resources that can be used in the event of a crisis, he said. “The first party to suffer is the defaulting party before anyone else,” he said. “That’s not what’s going on here.
Part of the problem is that Tsingshan’s position was so large and was mostly held in derivatives that are not traded on exchanges pulled from multiple banks, according to a person close to the situation. The exchange only saw a fifth of the full position and only learned of the full scale this week when the banks disclosed their holdings. Tsingshan brokers, incurring potentially huge trading losses, will have to close these OTC positions.
“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.
Chamberlain acknowledges that unraveling the knot to satisfy all involved may be beyond the exchange, and he faces a battle to restore trust with his electronic users.
“We have a task to restore our reputation in this market segment. I think this gives us the opportunity to finally put in place the necessary market protection,” he said.
Those defenses could include greater disclosure of clients’ off-exchange positions, a move Chamberlain promoted as CEO but resisted by banks. The LME has also introduced some emergency measures, including a 10 percent cap on the movement of nickel.
The exchange has a dominant global share of commodities such as aluminum, copper, nickel and zinc, outperforming the CME Group, the Chicago Futures Exchange.
Nickel is expected to be the battlefield of the future because it is used in electric vehicles. The CME does not currently have nickel futures contracts, but the LME’s missteps could prompt a rethink, spurred on by frustrated traders.
“These things don’t happen overnight, and reallocating liquidity isn’t easy. But yes, we will definitely support it,” said Yao Hua Ooi, co-lead of the macro strategy group at AQR.
“If they [the LME] lose the position they have in this metal, the upside potential for the LME will be very dire,” said the former top executive. “If they don’t respond, CME will eat their lunch and the pricing benchmark will move out of London.”