In markets, there are few principles considered by traders more sacrosanct than when a commitment to a deal is made, it should stand come what may.
So there was uproar in the global trading community over the London Metal Exchange’s decision to bring the global nickel market to a halt and cancel futures trades because of a vicious “short squeeze” on a Chinese tycoon facing potential billions of dollar of losses.
“This is one of the most inept moves an exchange has made that I can think of,” said Don Wilson, founder of Chicago trading firm DRW. Clifford Asness, founder of hedge fund AQR, also has railed against the LME’s decisions, tweeting: “I been doing this for a wee bit of time. This is one of the worst things I’ve ever seen.”
In one of the most controversial moments in its 145-year history, the LME cancelled a day of trades after a near doubling of its prices for nickel, a global benchmark for a metal used in stainless steel and electric vehicle batteries.
The rally had left Xiang Guangda, the tycoon behind Tsingshan Holding, China’s leading stainless steel group, struggling to meet demands for extra cash on a huge bearish bet that backfired. The LME believes that if had it forced the settlement of the trades, it would have imperilled some of its smaller members and its decision was “in the interests of the market as a whole”.
But US futures industry executives were taking a very different view at their annual conference in Boca Raton, Florida, this week. On the other side of the trade to the Chinese tycoon were electronic traders, who seek to profit from successful bets on the value and direction of nickel contract product. They are a key component of a deep and liquid modern market.
The traders allege favouritism was shown by the LME to the short seller and the brokers facing losses from unpaid calls to provide collateral on trades. At Boca Raton, angry traders kept returning to the LME’s decision to bust so many trades, so late in the day.
The convention is to let trades stand because traders usually hedge their deals with a bet in the opposite direction with a different asset. Cancelling one trade leaves a trader unhedged and exposed to losses. On the rare times erroneous trades occur on exchanges, those prices are later adjusted to bring them in line with the prevailing market price. It typically covers a few minutes’ of trading.
Rostin Behnam, chair of the Commodity Futures Trading Commission, commented that the public and the market had to have confidence that agreed rules would be upheld. “It’s extremely important that we don’t make up rules as we go,” he said. He did not name names but it was hard to escape the conclusion that he was referring to the LME.
If the LME loses customers as a result of the furore, there is risk that spreads between bids and offers for contracts become wider and the market less liquid, damaging the exchange’s credibility.
Many executives said they would look at alternatives to the London benchmark for nickel to trade. The Shanghai Futures Exchange has a nickel contract, but few relished connecting with the onshore Chinese market. US duo CME and Intercontinental Exchange could launch a rival version, but it can take months of discussion to gauge interest and agree specifications. Moreover, agreements would have to be struck to cover shipments — no small matter in a world still suffering supply-chain issues.
These obstacles may make reform of the LME the easiest option, but it will take something radical to restore faith. One suggestion from angry traders was that the LME might need a new owner to replace parent Hong Kong Exchanges and Clearing.
One intriguing answer floated at Boca Raton would be to consider futures based on blockchain technology. A smart contract could authenticate the quality and track shipment of the metal. Crucially, advocates say, it monitors customers’ market positions in real time. If someone does not have enough collateral to cover their trades, algorithms will automatically reduce and rebalance the customer’s position. There are no margin calls, no favouritism. Crypto derivatives exchange FTX this month applied for US regulatory approval for futures contracts based on precisely that model.
Futures trades that are settled with the physical delivery of a commodity are another matter though. Nickel producers would need to be persuaded to put their goods on a blockchain. Even so, the LME will not easily be forgiven by the customers it tried to court. The heart of the nickel crisis may lie in China and exploded in public in London, but the momentum for serious change is coming from America.
philip.stafford@ft.com
