Hitting its limits

The value of a commodity is expected to rise and fall, but what happened to nickel traded on the London Metal Exchange (LME) this March was difficult to explain from a purely supply-and-demand perspective.

The aftermath of the massive price swing has included changes to existing LME nickel trading rules, an investigation by the LME itself as well as by some outside organizations and agencies, lawsuits by some parties involved in the March incident and uncertainty about nickel price discovery several months later.

Although neither investigations nor lawsuits have had time to take their course, participants in the nickel and stainless steel sectors remain keenly interested in whether the LME nickel contract is being restored as a globally accepted standard.

Not quite there yet

In an August email to its clients, the LME writes that it has “put in place several interim measures to ensure an orderly resumption of nickel trading.”

These measures have included the application of 15 percent daily upper and lower price limits on nickel and what the LME calls “improved visibility of both on-exchange and OTC [over the counter] client positions in nickel.”

The exchange also points to a weekly OTC position reporting framework for all LME physically delivered metals that will go into effect Sept. 5. The LME says that framework “will enhance our visibility of OTC markets and, therefore, improve our ability to oversee activity holistically for the benefit of the market as a whole.”

Reporting by Bloomberg and other media outlets indicates that in mid-March, numerous companies held sizable positions on the price of LME nickel moving in one direction or the other as the unprecedented 250 percent price spike was underway.

While some of the positions in March were held by metals companies, many other claims were staked by banks and hedge funds that saw an opportunity to take advantage of a volatile situation. The balance between how a metals exchange can attract metal inventory as well as outside investors remains a source of debate.

In the meantime, LME as a venue for nickel trading has not fully recovered from the March incident, according to sources.

Citing research conducted by his colleague Vincenz Bracke, John Browning of Hong Kong-based BANDS Financial says LME nickel trading had been heading on a downward trajectory even before the volatility incident.

“LME nickel three-month volumes fell significantly in mid-2020 following the lockdown in the United Kingdom, which led to the closure of the LME Ring,” Browning says. “Following the reopening of the LME Ring, volumes did not recover significantly. Following the events in March 2022, volumes have fallen further to perhaps 30 percent of their 2021 volumes as nonhedge participants have stayed away.”

On the LME, hedge participants typically are physical metal producers or buyers locking in a price. Banks and large funds, meanwhile, “take positions on the exchange based on their view of the future direction of these market trends,” in the words of the LME’s own 36-page “Detailed Guide to the London Metal Exchange.”

The LME decision to not only freeze nickel trading but to “unwind” numerous trades that occurred March 16 has resulted in the lawsuits and subsequent lack of financial institution participation.

© KanawatTH | stock.adobe.com

Is there a return journey?

Veteran metals trader Michael Lion, who is with Hong Kong-based Everwell Resources Ltd. and chair of the Brussels-based Bureau of International Recycling International Commerce Committee, says the reduction in LME nickel trading volume cited by BANDS Financial is not a plus for the scrap recycling sector.

The LME has long served “the global metals industry as the basis for benchmark pricing of an unapparelled range of base metals far beyond its own on market transactions,” Lion writes in an essay posted to his LinkedIn account.

He continues, “The disruption caused by the nickel crisis and its wider ramifications has undermined these vital functions as a result of aberrant activity incompatible with the fundamental objectives of establishing unmanipulated fair and reflective pricing of the commodities traded.”

The LME has played that role, Browning says, but whether the LME will retain this role is not guaranteed. “Since the LME’s inception, LME traders have made an excellent job in persuading the planet that the closing second ring price represents the total of all the bids and offers available in the metals industry at the moment the second ring closes,” he adds.

“However, commodity prices are a function of location, quality and delivery date,” he continues. “So, to some extent, the LME changed the parameters of that statement by deferring delivery dates, which caused seismic pricing issues downstream. The absence of a closing price and the cancellation of trades only caused unease that the LME still represents a value-free pricing point. The LME will argue that they needed to act to preserve the exchange; it is a point, in time, the market may accept.”

The Shanghai Futures Exchange (SHFE) offers a nickel contract, but it has not necessarily been a beneficiary of the LME fiasco.

“The highly speculative and totally domestic-based and restricted SHFE contract really cannot replace the international pricing of nickel,” Lion says.

Within China, some trading volumes “have migrated to SHFE, but the SHFE has seen falling nickel volumes also driven by COVID-19 issues and the Chinese economic slowdown,” Browning adds.

Browning, who is based in Shanghai for BANDS, points to the OTC contract status mentioned by the LME itself as a factor in the March meltdown. Referring to the China-based stainless steel producer on the “losing” side of the trades that were canceled, he says, “It must be remembered that Tsingshan was largely using unregistered OTC contracts offered to them by their banking partners. I suspect very few of these contracts now exist and Chinese LME-linked price exposures, such as they are, have migrated to on-exchange LME contracts.”

With limits in place, the LME nickel contract continues to attract (reduced) traffic, and the SHFE remains off-limits to traders or investors outside of China.

The United States-based CME Group reportedly has explored creating a nickel sulfate exchange contract to serve the growing electric vehicle (EV) battery market, but CME itself has not made any such announcement. (See the sidebar, “Charging into the market,” below.)

A need to wait

Looming growth in demand for nickel in EV battery applications was a source of conversation at an LME venue as far back as 2018, with one LME Asia Week panelist urging battery makers that use nickel “to lock in prices now.”

Lion says the EV market enthusiasm might have been one of the prompts that brought speculation-minded bankers and fund managers to the LME nickel arena.

“For a number of reasons, the commodity markets assessed that a broad consensus believed that a demand surge would imply a general swathe of higher prices,” he writes on LinkedIn. “This was exacerbated in the case of nickel by belief that the supply-demand balance would be significantly altered by battery demand focused on the burgeoning production for the EV industry.”

While some in the financial press have looked askance at the role of Tsingshan and its board chair Xiang “Big Shot” Guangda in the March meltdown, Lion is more inclined to examine the role of banks and, in his words, inappropriately named “hedge” funds.

“The technical vulnerability of exchange-established hedge sales provided a pretext for financial rather than metals trade players to embark on a classic squeeze of the nickel futures sales positions on the LME, culminating in buy orders on the exchange,” Lion says.

Much of this activity, he continues, “arguably strategically and opportunistically emerged in the thinly traded Asian opening trading hours with a gargantuan uptick to, as it transpires given current prices, utterly unsustainable aberrational prices.”

Because the LME shut down its nickel trading network and unwound trades at the tail end of the upward price move, some companies on the “winning” side of these trades have sued the LME pertaining to money they would have received had those trades gone through.

It seems likely that 2022 will turn to 2023 and the LME nickel trading fiasco will be far from resolved. Of its own investigation, the LME says, “The review will include extensive market engagement and data collection and is expected to run until December 2022, with the intention of publishing a final report at the end of this process.”

Pertinent lawsuits were filed this June and likely have a lengthy discovery process ahead before anything resembling a settlement or trial date is announced.

And while it might be tempting to consider the March incident squarely in the rearview mirror, Browning is not certain. He tells Recycling Today exchanges in China, such as the SHFE, “charge initial margins at 8 percent and the limit up/limit down is, maybe 7 percent. Chinese brokers will still have 1 percent, a slim margin of client liquidity, should there be a disruptive event.”

LME rules still might leave too much room for traders to go deeply under water, he adds. “Today, LME Clear initial margin (IM) on LME copper is 8 percent, but the limit up or down is 15 percent. Should there be a disruptive event, LME copper prices will move above client funding and exhaust the 8 percent IM buffer, from which point the LME broker is liable to pay the additional 7 percent to the exchange in real time. Although now capped at 15 percent, this is the same issue that ripped the nickel market apart in March.”

The author is senior editor with the Recycling Today Media Group and can be contacted at btaylor@gie.net.