In markets, there are few principles considered more sacred by traders than when a commitment is made to a deal, it must stand no matter what.

So there was an uproar in the global trading community over the London Metal Exchange’s decision to shut down the global nickel market and cancel futures trades over a vicious “short squeeze” on a Chinese tycoon facing potential losses of billions of dollars.

“This is one of the most inept moves that an exchange has done that I can think of,” said Don Wilson, founder of the Chicago trading company DRW. Clifford Asness, founder of hedge fund AQR, has also spoken out against the LME’s decisions, tweet: “I’ve been doing this for a while. This is one of the worst things I’ve ever seen.”

At one of the most controversial moments in its 145-year history, the LME canceled a trading day after prices nearly doubled for nickel, a global benchmark for a metal used in stainless steel and electric vehicle batteries.

The rally had left Xiang Guangda, the tycoon behind Tsingshan Holding, China’s leading stainless steel group, struggling to meet the demand for extra cash on a massive bearish bet that backfired. The LME believes that if it had forced the settlement of the transactions, it would have put some of its smaller members at risk and its decision was “in the best interest of the market as a whole”.

But US futures industry executives took a very different view this week at their annual conference in Boca Raton, Florida. On the other side of trading against the Chinese tycoon were electronic traders, seeking to profit from successful betting on the value and direction of the nickel contract product. They are an important part of a deep and liquid modern market.

The traders claim that the LME has shown favoritism to the shortseller and the brokers who suffer losses from unpaid calls to provide collateral for trades. At Boca Raton, angry traders kept coming back at the LME’s decision to halt so many trades so late in the day.

The convention is to leave trades as traders usually hedge their deals with a bet in the opposite direction with another asset. Canceling one trade leaves a trader unhedged and exposed to losses. On the rare occasions when erroneous trades occur on exchanges, those prices are later adjusted to bring them in line with the prevailing market price. It usually takes a few minutes of trading.

Rostin Behnam, chairman of the Commodity Futures Trading Commission, noted that the public and the market needed to be confident that the agreed rules would be followed. “It’s extremely important that we don’t make up rules while we’re at it,” he said. He didn’t name names, but it was hard to avoid the conclusion that he was referring to the LME.

If the LME loses clients as a result of the furor, there is a risk that spreads between bids and offers for contracts will widen and the market become less liquid, damaging the exchange’s credibility.

Many executives said they would look at alternatives to the London benchmark to trade nickel. The Shanghai Futures Exchange has a nickel contract, but few have enjoyed its connection to the Chinese onshore market. American duo CME and Intercontinental Exchange could launch a rival version, but it could take months of discussion to gauge interest and agree on specs. In addition, agreements should be made to cover shipments – no mean feat in a world that still struggles with supply chain problems.

These obstacles may make reform of the LME the easiest option, but it will take something radical to restore faith. One suggestion from angry traders was that the LME could need a new owner to replace its parent Hong Kong Exchanges and Clearing.

An intriguing response to Boca Raton would be to consider futures based on blockchain technology. A smart contract can verify the quality and track the shipment of the metal. According to proponents, it is crucial that it monitors customers’ market positions in real time. If someone doesn’t have enough collateral to cover their trades, algorithms will automatically shrink and rebalance the client’s position. There are no margin calls, no favoritism. Crypto derivatives exchange FTX this month filed for US regulatory approval for futures contracts based on exactly that model.

However, futures transactions settled with the physical delivery of a commodity are a different matter. Nickel producers should be persuaded to put their goods on a blockchain. Still, the LME will not be easily forgiven by the clients he has taken to court. The heart of the nickel crisis may be in China and it exploded publicly in London, but the momentum for serious change is coming from America.

philip.stafford@ft.com


This post Traders in turmoil over the LME was original published at “https://www.ft.com/content/3a4748f7-f47e-4891-95be-377561666b48”

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