LME's Nickel Review Shows How Exchange Could Have Prevented Crisis

The long-awaited report on the nickel crisis that brought the London Metal Exchange to its knees last March has finally been released. The report details a number of failings by the 146-year-old exchange.
The report, commissioned by the LME and carried out by consultancy Oliver Wyman, is likely to be the start of a year of reckoning for the exchange. It faces regulatory investigations, lawsuits and a battle to rebuild faith in its contracts.
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The report left many key questions unanswered by design. It avoided passing judgment on the LME’s most controversial decisions – allowing the market to reopen on March 8, then suspending it and canceling billions of dollars of trades – which are at the heart of the lawsuits brought by Elliott Investment Management and Jane Street against the LME.
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Oliver Wyman conducted a forensic review of trading in the nickel market, but the public report did not go into detail on whether it found any manipulative behavior.
The report did identify a number of issues at the LME in the lead up to March 8th, when prices spiked to a record high of $100,000 a ton. This short squeeze was described as "unprecedented in a major commodity in recent times" and compared to the Hunt brothers' attempt to corner the silver market in 1980.
The report also made a series of 27 recommendations to improve the LME's rules and procedures, including increasing oversight of the over-the-counter market, introducing tougher position limits, and strengthening requirements for clearing members.
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"There are definitely lessons that can be learned from March," said Matthew Chamberlain, the LME's chief executive officer, in an interview. "We now have a clearer idea of what we can do to try to rebuild confidence in the market."
The LME said it has no fundamental disagreements with any of the recommendations and will publish an action plan by the end of March. It will start implementing some changes as soon as the plan is published, with others coming later this year after a consultation period. Some changes may require changes to trading systems that could take 18 to 24 months.
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The price of a metric ton of a commodity can vary depending on a number of factors, including the current market conditions and the availability of the commodity.
One of the most striking findings in the report was the LME’s failure to understand and police the large positions in the nickel market. The report didn’t name any individual market participants, but noted that Bloomberg reported several weeks before the crisis that Tsingshan Holding Group Co. had a large short position in LME nickel. Bloomberg subsequently reported that the Chinese company’s inability to meet margin calls was at the center of the short squeeze.
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The LME failed to spot the risk in part because much of Tsingshan's position was held in the OTC market, which the exchange doesn't control or oversee.
LME Group management explained that when they looked at the risks associated with certain large positions, the fact that there was a large on-exchange component made it appear as though that was the entirety of the beneficial owner's position, when in reality there was a larger position held OTC.
According to the report, while banks and brokers were making unprecedented margin payments to the exchange, their clients were missing out on billions of dollars in margin calls on their OTC contracts. Two clients alone accounted for more than $2 billion in missed OTC margin calls.
As nickel prices surged, clients failed to meet large margin calls in the over-the-counter market.
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Since the financial crisis, the London Metal Exchange (LME) has introduced rules forcing members to report details of their over-the-counter (OTC) positions. However, a recent report has called on the LME and regulators like the Financial Conduct Authority to work on additional ways to reduce risks in the OTC market.
The exchange also failed to properly oversee large positions in the market. While the LME sets “accountability levels,” above which a trader can be asked to explain and justify their position, it focused its inquiries on attempted corners of specific delivery dates, rather than large positions that were spread across multiple delivery dates.
The report recommended introducing position limits at levels that make them "effective protection against speculative positions causing extreme price fluctuations." This would have allowed the LME to identify significant OTC exposures being run by multiple members and prevented extreme price fluctuations.
According to the report, the LME's controls on price volatility were insufficient at the time of the crisis. The exchange did not have trading limits or circuit breakers in place, though it has since introduced a 15% daily price limit.
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The report also took aim at the LME’s clearinghouse, arguing that the composition of its membership – including numerous small brokers specializing in the LME – “can give the perception that the clearing system is less robust than elsewhere.” As a result, the report recommended that LME Clear should enhance safeguards around member composition, potentially including increasing minimum capital requirements and imposing stricter risk management controls.
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The independent review has confirmed our concerns that the LME lacked the systems and controls to manage through the March 2022 nickel crisis,” said Jennifer Han, head of global regulatory affairs at the Managed Funds Association. “LME failed to maintain an orderly market, manage conflicts of interest, or protect investors in the nickel market and must institute controls so market participants can engage in these markets with confidence.”