Last month’s chaos in London Metal Exchange nickel trading has shone a light on the failure of a core reform from the global financial crisis to help regulators quickly spot destabilising risks in markets.
The 2008 Lehman Brothers crash and bailout of insurer AIG prompted G20 leaders to increase transparency in over-the-counter (OTC) or off-exchange derivatives such as credit default swaps by making it mandatory to report transactions to repositories.
Regulators can then scan that data to find out exactly who was behind a risky position and take action before the financial system is threatened.
A real test of those rules came last month.
Used in stainless steel and increasingly in-demand electric vehicle batteries, nickel had already been on a tear, but major producer Russia’s invasion of Ukraine lit a fire under the market.
On March 8, prices doubled to record highs, and the LME, judging trade to have become disorderly, was forced to halt nickel trading for a week.
The surge in prices was largely driven by expectations of purchases by China’s Tsingshan Holding Group to cover a short position it had built up in recent months – exactly the kind of pattern the post-2008 system was designed to spot.
But while deals executed by London-based market participants are reported to a repository in the same location – DTCC, part of the U.S. DTCC securities settlement company – Tsingshan’s exposure was through banks operating in Asia, where reporting practices and repositories differ.
Disclosure rules notwithstanding, British regulators looking at data collected on their own patch would not have been able to see the entire short position Tsingshan had been building.
“If the regulators suspect something is amiss they could look at it, but I suspect that joining the dots to identify the large nickel OTC and LME positions would not be easy,” said Robert Finney, a commodities consultant with Holman Fenwick Willan.
Britain’s Financial Conduct Authority, which regulates the LME, has opened an investigation to see what lessons can be learned from the chaos on the nickel market. It declined to comment beyond the statement it issued last week.
“This was a Black Swan event, something regulators didn’t think would originate from the metals industry,” a metal industry source said. “It has certainly made them sit up.”
The LME said it “has no direct visibility of OTC transactions and positions”. The DTCC said rules regarding data access vary in every jurisdiction, declining to comment on any specific company.
The 2009 repository reform aimed to spot risks between banks before they get out of control, Lehman-style, but the nickel saga shows the problem has not gone away, Damon Batten, global capital markets practice lead at regulatory consultancy Bovill, said.
So what can be done?
Regulators would find it easier to spot risks if there were a global one-stop-shop repository, a role the DTCC has sought to play. But repositories have mushroomed as more and more exchanges piled in to attract and retain trading volumes.
Even in Europe, Britain’s departure from the European Union has left the continent divided into two jurisdictions by volume, said the European Securities and Markets Authority, which regulates repositories in the EU.
Such a fragmented landscape makes it difficult to compile a cross-border snapshot of positions. And according to Bovill’s Batten, regulators in different countries do not have the kind of detailed cooperation needed to track positions in a timely way from repository data.
It would be hard to track a position cross-border even if regulators knew what they are looking for, let alone to have the goodwill of another regulator to go on a ‘fishing expedition’ on their turf to check for potential risks, he added.
Reporting to repositories has also been dogged by poor quality and incomplete data, ESMA said, with about a fifth of the data not updated on time to reflect position changes.
In 2021, the DTCC was fined 408,000 euros ($441,619) by the EU watchdog for failing to give regulators direct and immediate access to data. Rival repository REGIS-TR was fined 186,000 euros in March for giving wrong and unreliable reports.
“If the objective was to give a full view of systemic risks in the system as a result of OTC derivatives, we are still a long way from that,” said Batten.
“If you could not spot a build-up in nickel, how could you spot a big build-up in a credit default swap position that would be systemic?”
($1 = 0.9239 euros)
(By Huw Jones and Pratima Desai; Editing by Jan Harvey)