Britain’s Financial Conduct Authority (FCA) and the Bank of England (BoE) have announced a rare joint intervention into what happened on the London Metal Exchange’s nickel market (LME).
The LME suspended disorderly nickel trading on March 8 after prices doubled to a record above $100,000 a tonne in a few hours on expectations that China’s Tsingshan had to buy metal to cover its short position.
The FCA regulates the LME, while the Bank of England regulates the exchange’s clearing house. Both also regulate many of the banks and investment firms who use the LME.
The FCA will look into the LME’s approach to managing the suspension and resumption of nickel trading to determine what lessons might be learned in relation to the LME’s governance and market oversight arrangements. The BoE will look at what changes may be needed at LME Clear.
The BoE and FCA will also be talking to firms which held significant positions in the nickel market to assess the effectiveness of their risk management and governance.
Market officials say many questions need answering to avoid any long-term blemish on London as a global financial centre.
How much was the impact of Russia’s invasion of Ukraine upending commodity market to blame? To what extent are there longstanding systemic issues at the exchange that need tackling?
The FCA and Bank review will be backed by independent fact-finding reports paid for by the LME, which will help the regulators decide if enforcement action is needed.
The LME has already agreed with regulators on the benefits of appointing extra independent directors to the board to improve governance.
Market participants want to know how decisions were made and what they were based on. Should the LME have allowed night trading on March 8 after nickel prices jumped 90% to $55,000 a tonne on the previous day.
Metal industry sources say this should have raised a red flag for the exchange, which eventually suspended trading on March 8 at 0815 London time.
The events have raised the broader issue of operational resilience, now a major focus of regulators across markets. It refers to the ability of companies and infrastructure to withstand extreme volumes or price moves, or recover quickly from hacking or outages.
Suspending nickel trading for a week left the market without benchmark prices for contracts between producers and consumers, such as stainless steel and electric vehicle battery makers.
There are currently no easy alternatives.
LME trades must be reported to a trade repository so that regulators can spot problems early, raising questions about the speed of supervision.
But the exchange said part of the reason behind the nickel fiasco was because it has an incomplete view of the market, especially off exchange or over-the-counter trades done privately between banks or broker and their customers.
The LME proposed in January last year that members should report OTC trades, but most respondents said it would be too complicated and costly.
After the suspension the LME toughened its rules on how big a position can be held, known as accountability levels: it now includes OTC as well as on-exchange positions and a breach of these levels allows the exchange to stop members from adding to a position, or force them to reduce it.
Every clearing house must have a default fund to cover losses which margins posted by members are unable to plug.
Since the nickel debacle, the LME has forced its members to contribute more to the $1.1 billion default fund, almost doubling it to about $2 billion, a significant increase. The exchange cited rising metal prices in recent months, but industry officials say there may have been concerns it had been too small in the first place.
The BoE will want to show it was properly supervising LME Clear given that Britain is trying to persuade the European Union to grant UK clearers long-term access to EU clients.
(By Pratima Desai and Huw Jones; Editing by David Evans)