Nickel price surge threatens to create USD 2.6 billion loss for key LME entity, new report shows

Analytics recap. Nickel. Early December.

Based on analysis by the Financial Times.

The London Metal Exchange (LME) clearing house, a crucial organization created to stop problems in one market from spreading to the wider financial system, was in danger of failing in March, according to judicial files disclosed this week. According to the documents, the LME's clearing house suffered a USD 2.6 billion loss, and its stability fund – an additional layer of security – would have been all but depleted. The information sheds light on why senior LME executives took the rare step of stopping trade and cancelling deals worth billions of dollars on 8 March.

The LME was defending itself against a USD 470 million legal challenge brought by US hedge fund Elliott Investment Management and Jane Street when the filings were made. When it cancelled the trades, the LME – which is owned by Hong Kong Exchanges and Clearing – was charged with violating regulatory requirements.

Prices for nickel, which is needed to produce steel and batteries for electric vehicles, increased by 230% in a single day. This would have required up to USD 20 billion in margin payments from LME members, and presented a potential ‘death spiral’ for the LME and its members as it was ten times higher than the previous record established on 4 March. The price spike was prompted by a significant wager placed by Chinese steelmaker Tsingshan on declining nickel prices that lost out due to the rapid rise in prices.

The documents state that at a meeting held internally on 7 March at 13:45 GMT, the LME's clearing house opted not to request any additional margin calls, which it acknowledged was "extremely unusual and a departure from internal policy." The LME claimed that if it had allowed eight hours' worth of deals to stand, up to seven of its members could have been unable to make payments to the clearing house. The court documents also make plain that the LME's own clearing house was in grave danger, posing "a serious systemic risk to the wider financial system" and possibly preventing the LME from trading other metals. The LME declined to make any additional comments.

When the trades were cancelled, the LME was charged with violating its regulatory obligations. The LME's primary regulators, the Financial Conduct Authority and the Bank of England, are reviewing how the LME handled the situation. An impartial investigation into the circumstances leading up to the nickel market crunch is also being led by consultants Oliver Wyman. The report is due by the end of the year.

The lengthy defence, according to Colin Hamilton, Managing Director - Commodities Research at BMO Capital Markets, added more information on the potential severity of the issue that was initially started by the small (3 million tonnes per year) nickel market.

“The fact that a market so small could cause severe financial strain will undoubtedly catch the eye of the regulators,” he said.