By Rodrigo Zepeda, CEO, Storm-7 Consulting Limited 

[Part I of a four part blog series]

It has been recently reported that the London Metal Exchange (LME) is being sued by affiliates of the New York hedge fund 'Elliott Management' for $456 million (£363 million), because of the LME's decision to suspend trading in nickel contracts and to cancel nickel trades that had been legally executed on 8 March 2022. In practice the LME is now legally owned by Hong Kong Exchanges and Clearing Ltd. (HKEX).

This multiple part blog will provide commentary on: (1) the actions that led to the suspension of nickel trading on the LME market; (2) the unprecedented cancellation of nickel trades by LME; (3) the actions taken by ‘Tsingshan Holding Group Co. Ltd’ (Tsingshan); (4) the position taken in the legal claim brought by Elliott Management; and (5) the potential long-term impact on trust and confidence of participants and investors in the LME nickel market.

BACKGROUND

The Nickel Trading Market before the intervention by LME

In February 2022, the nickel commodities market had been exhibiting low trading volumes with nickel selling for less than $25,000 per tonne. However, Russia’s invasion of Ukraine at the end of February 2022 led to a surge in nickel demand due to a combination of supply concerns and a short squeeze (Whitson, 2022). First, in terms of supply concerns, since Russia controls around 17% of the world’s high-grade nickel, supply concerns arose owing to Russia’s invasion of Ukraine, resulting in a surge in nickel prices (Whitson, 2022).

Second, in terms of a short squeeze, the world’s largest aluminium and nickel producer, Chinese owned Tsingshan, had been building up a short position on nickel starting in 2021, and was betting heavily on the LME that the price of nickel would fall.  As will be seen, a short squeeze was therefore subsequently triggered in the LME nickel market, owing to the fact that Tsingshan had been seeking to purchase nickel to reduce its outstanding nickel short bets.

The Legal Claim asserted by Elliott Associates and Elliott International

LME and LME Clear Limited were named as defendants in a judicial review claim filed in the English High Court that was initiated by affiliates of Elliott Management, namely Elliott Associates LP (EALP) and Elliott International LP (EILP). The claim contended inter alia that the suspension of trading and cancellation of trades by LME was unlawful based on public law grounds (i.e., the LME exceeded its authority or acted unreasonably and irrationally), and also that such actions constituted a violation of the claimants’ human rights.

LME’s POSITION

In a public announcement made on 8 March 2022 (Ref: 22/052), the LME stated:

“Following further unprecedented overnight increases in the 3 month nickel price, the LME has made the decision to suspend trading for, at a minimum, the remainder of today (Tuesday 8 March 2022).”

The suspension of nickel trading took effect as of 8.15 am London time on 8 March 2022. In providing a brief explanation of its underlying rationale, the LME stated:

“The LME, in close connection with the Special Committee, has been monitoring the LME market and the effect of the evolving situation in Russia and Ukraine. It is evident that this has affected the nickel market in particular, and given price moves in Asian hours this morning, the LME has taken this decision on orderly market grounds…

The Exchange will further consider whether trades booked prior to 0815 today should be subject to reversal or adjustment, and will again update the market as soon as possible.”

The LME subsequently cancelled all legally executed trades made on 8 March 2022 prior to the 8.15 am London time suspension of trading. The LME commented:

“Cancellations were made retrospectively to take the market back to the last point in time at which the LME could be confident that the market was operating in an orderly manner. It should be stressed that the LME always acted in the interests of the market as a whole.” (Makortoff 2022).

The decision by the LME to suspend nickel trading in conjunction with its subsequent decision to retrospectively cancel nickel trades legally made on 8 March 2022, has proved to be highly controversial in practice. It has drawn criticism by the International Monetary Fund (IMF); it has drawn wide criticism from investors (Hunter, 2022); it has sparked a regulatory investigation in the United Kingdom (UK) over the suspension and cancellation of those trades; and it has resulted in the commencement of litigation by affiliates of Elliott Management in the English High Court.

THE POSITION TAKEN BY TSINGSHAN

According to Reuters, Tsingshan’s bets on lower nickel prices amounted to around 300,000 tonnes at an average price ranging between $18,000 and $19,000 a tonne (Desai 2022). However, on Friday 4 March 2022, the LME announced that it would raise its margin requirements for nickel contracts by 12.5% to $2,250 per tonne, effective at close of business on Tuesday 8 March 2022 (Onstad 2022). At that time, Nickel prices peaked at approximately $30,295 a tonne.

This meant that Tsingshan’s margin capital requirements alone for 300,000 tonnes would have been approximately $675 million (at $2,250 per tonne) (Desai 2022). In practice, this translated to mean that Tsingshan had until close of business on Tuesday 8 March 2022 to drastically reduce its nickel contracts in order to reduce the new margin capital requirements that would be imposed at close of business on that day.

Consequently, Tsingshan began to buy larger amounts of nickel in order to reduce its outstanding short bets (and the size of future LME nickel margin calls) causing nickel prices to spiral upwards (Onstad 2022). On Monday 7 March 2022 nickel prices had soared up by 30.7% to $37,800 (Soreng 2022). However, on Tuesday 8 March 2022 nickel prices had doubled to a record $100,000 (£76,200) per tonne before nickel trading on LME markets was halted.

On Monday 7 March 2022, Tsingshan’s trading losses already stood at approximately $8 billion (S&P Global 2022). In practice, the fact that nickel prices more than doubled from Monday 7 March 2022 to Tuesday 8 March 2022, meant that the $8 billion losses already accumulated by Tsingshan would have been acutely magnified were it not for the intervention by LME and the tearing up of all legal executed nickel contracts made on Tuesday 8 March 2022 from 00.01 am to 8.15 am London time.

So, prior to the intervention by LME, on the one hand, we would seem to have $8 billion in financial losses by Tsingshan that were directly incurred as a result of market speculation via a shorting of nickel contracts on the LME market that were set to be exponentially magnified. And, on the other hand, we would seem to have a range of financial market participants that have taken long positions in nickel contracts to potentially hedge market risk, and that seek to benefit from investor gains in any future increased price of nickel contracts.

THE IMF PERSPECTIVE

In its April 2022 Global Financial Stability Report (GFSR) (IMF 2022), the IMF unequivocally stated that:

“Governance mechanisms for the LME need to be strengthened to address conflict of interest.” (GFSR 2022, pp.35-36).

The LME had full operational knowledge of the historical build-up of positions taken by China’s Tsingshan throughout 2021 and 2022. The IMF observed that measures should be put in place to ensure that concentration of trading does not adversely impact free and fair markets, and that both supervisors and regulators should consider enhancing transparency in order to pre-empt any build-up of concentrated positions, which would limit financial stability implications (GFSR 2022, p.36).

Consequently, the IMF stated that recent developments relating to the LME nickel market suggested that there were a number of potential lessons for policymakers to consider (GFSR 2022, p.36). The IMF noted that:

“While the stated objective of the cancellation of trades by the LME was to stabilize the nickel market, counterparties with long positions were put at a disadvantage.” (GFSR 2022, p.36).

The IMF further noted that:

“Broadly speaking, a disruption in trading needs to balance financial stability and free and fair market objectives; the adequacy of governance mechanisms of market infrastructure institutions requires careful review from the perspective of mitigating conflict of interest” (GFSR 2022, p.36).

The crucial issue identified here, was who did the LME’s suspension of the nickel market and its retrospective cancellation of nickel trades ultimately benefit? Was it actually nickel market participants as a whole? Or, was it a certain type of market participant, namely those large institutions such as Tsingshan that held nickel short positions, were Chinese owned, and would significantly benefit from cancellation of nickel trades by drastically reducing outstanding market trading losses?

The UK’s Financial Times sets out the notion that, in actuality, the LME’s decision to cancel several billion dollars’ worth of nickel trades could have been the direct result of pressure from members, their banks and even the LME’s parent company, the HKEX (Wigglesworth 2022). This raises the question of whether or not conflicts of interest arose, and if so, how these were identified and effectively dealt with, or if they were even identified at all in the first place.

Additionally, it has been asserted that the intervention by LME significantly limited the financial losses suffered by Tsingshan, which may have been seen as a LME ‘crony’, thereby reflecting the accuracy of the IMF’s commentary regarding the LME harbouring conflicts of interest that could potentially affect free and fair markets (White 2022).

If market participants believe that the LME will step in to protect Chinese owned companies whilst 'unamed foreigners' have all their legally executed contracts cancelled, thereby resulting in a loss of significant and extensive profits, confidence and liquidity in LME nickel markets will very likely significantly tumble in the long-term. It would seem to be the case that, at present, as will be seen in the next part of this blog, the legal claims initiated by EALP and EILP may shine a very bright and extensive spotlight on the underlying justification of LME actions.    

TO BE CONTINUED.

The next parts of the blog will provide commentary and analysis on the position taken by EALP and EILP, and the potential long-term impact on trust and confidence of participants and investors in the LME nickel market.