(Bloomberg) — The first short squeeze to plunge the London Metal Exchange into an existential crisis came more than a century ago. In 1887, French industrialist Pierre Secretan began cornering the copper market, with prices more than doubling before losing his grip and causing them to collapse.
In the years since, the exchange has survived world wars, scandals and bankruptcies to cement its place as the institution of the City of London: home to global benchmark prices for the world’s major industrial metals.
That status is now threatened. The reason is another short squeeze, this time in nickel, which is wreaking havoc on the metal world. Investors are furious with the LME for letting prices rise 250% in less than two days and then retroactively canceling $3.9 billion worth of trades. When it tried to reopen the market, the exchange’s electronic trading system repeatedly failed.
The LME’s outrageous role in how industrial metals are bought and sold means that angry traders and investors have few alternatives. But the ramifications of the nickel squeeze will cast a long shadow, leaving the exchange embroiled in investigations and lawsuits for years, raising questions about its structure, ownership and oversight.
“Suddenly the LME just looks incompetent,” said Mark Thompson, a mining executive and former metals trader at Trafigura Group, who has emerged as one of the stock’s most outspoken critics. “They need thorough reforms.”
In an interview, LME Chief Executive Officer Matthew Chamberlain says the past two weeks have been an “incredibly difficult time” for the market, and he aims to ensure that “an event of this nature never happens again”.
Founded in 1877 and now owned by Hong Kong Exchanges & Clearing Ltd., the LME fulfills multiple roles. For the metals industry, it is an essential supply, generating the prices set in almost every contract. For investors, banks and brokers, it is a place to make money.
It’s also an institution that had to be dragged into the 21st century, and not just when it comes to technology. It wasn’t until 2019 that it banned its floor traders from drinking alcohol during the day and cracked down on affiliates partying in lap dance clubs and casinos at their annual gathering in London.
Chamberlain has spent much of his career trying to win over new entrants, such as hedge funds, without alienating the stock market’s physical users.
Tensions came to a head on March 8, when the nickel price rose to over $100,000 a tonne. When the LME decided to cancel trading hours and roll prices back to $48,078, it chose the physical industry over the funds. In fact, it was a multi-billion dollar bailout of Chinese nickel magnate Xiang Guangda, who had a huge bet that prices would fall, and its banks, led by JPMorgan Chase & Co.
But the exchange was also a lifeline for other smaller nickel dealers and the specialist metal brokers who serve them, who also ran into trouble when prices rose.
If the events of March 8 were pompous, the LME fell into a farce last week.
Nickel trading was scheduled to resume at 8 a.m. Wednesday, but was delayed for several hours due to a software glitch. More transactions were cancelled. Similar embarrassing issues recurred over the next two days.
Chamberlain blames “a bug in the underlying third-party software” that the exchange overlooked when it rushed to implement the new price limits. “If we had waited for that bug to be fixed, we would have had to postpone the reopening.”
The debacle has confused owner HKEX’s plans for the LME. For most of the past decade, the LME has pinned its growth hopes on attracting US hedge funds and other financial investors.
Last year, Chamberlain clashed with the more traditional users of the LME over proposed changes designed to make the exchange more attractive to financial investors, including closing the iconic open-outcry trading floor, where dealers yell orders at each other from red leather benches.
Now many of those same financial investors are saying they can leave the LME. Some are involved in lawsuits in the US and UK, according to acquaintances.
A portfolio manager at a major macro hedge fund says he has already stopped trading LME contracts for its relative value book, which bets on price differentials between commodities, stocks and currencies. Alex Gerko, founder of XTX Markets, a major quantitative trading company, has dubbed the LME the “Soviet Metal Exchange”.
Chamberlain admits it will take work to regain investor confidence.
“Failing to restore credibility in the financial market will certainly affect our ability to grow,” he says.
Even before the nickel crisis, the LME had tried unsuccessfully to ramp up activity. Volumes have decreased and profits have remained the same. Volumes have already taken a hit since this month’s crisis as trading stalls in the nickel market, while dwindling activity in the other flagship contracts points to a wider hesitation to use the exchange.
For Chamberlain, it’s an empty coda for a decade-long LME career. He was halfway through the door when the crisis hit – he was due to leave the exchange at the end of April to run a crypto startup. He refuses to confirm whether he is still leaving, saying only, “I am still here and I will do what I can to resolve the situation.”
The task is nothing less than to secure the future of the stock exchange.
With daily price caps to avoid wild moves in the future, Chamberlain turns his attention to the over-the-counter market, where banks make bilateral deals linked to the LME but outside the oversight of the exchange. The vast majority of Xiang’s short position in nickel was held through such positions. He also said the exchange would aim for tighter position limits and stronger oversight of traders with large short positions.
While financial investors talk about exiting the LME, another risk to the stock market is that the physical metals industry will also retreat. Two weeks without normal nickel trading caused chaos for manufacturers and dealers. Spanish stainless steel producer Acerinox stops taking new orders.
Could other exchanges benefit from the LME’s struggles?
There are few alternative trading places for metals such as nickel, aluminum and zinc. CME Group Inc., which has a popular copper contract, is looking at opportunities in nickel, but is unlikely to take any hasty steps, according to those familiar with the matter. A CME spokesperson declined to comment. The other major metal exchange, the Shanghai Futures Exchange, is largely inaccessible to international traders.
But when the LME nickel market has been frozen for the past two weeks, the eyes of the world turned to the Shanghai contract.
“It is not impossible to imagine a scenario where in five or ten years’ time the LME will not be the global market, with Shanghai as its smaller sibling, but the other way around,” said Duncan Hobbs, research director at trading house Concord Resources Ltd.
The crisis also raises questions about HKEX’s plans. The new CEO of the Hong Kong stock exchange, former JPMorgan banker Nicolas Aguzin, has yet to outline his vision for the LME. And there was no shortage of other suitors for the LME when HKEX bought it in 2012. Thompson, the former Trafigura trader, says the events of the past two weeks indicate that HKEX is the wrong owner for the LME.
A spokesperson for HKEX declined to comment.
Certainly, HKEX has long viewed the LME as a strategic investment, said Shujin Chen, head of China FIG Research at Jefferies Hong Kong Ltd. examination of an asset that was considered a bad acquisition by some within the exchange.
When asked if he thought HKEX should consider selling, Chamberlain replied: “I don’t want to talk about what HKEX does or doesn’t want to do. But I would say that we have noted in the past that HKEX has always been a supportive owner of this exchange and has always wanted to do what is right for the exchange and its community.”
This post Nickel Squeeze Threatens London’s Place in Heart of Metals Trade was original published at “https://www.bloombergquint.com/markets/nickel-squeeze-threatens-london-s-place-at-heart-of-metals-trade”