ANALYSIS: LME maintains momentum in post-nickel reforms

The closure on March 8 2022, which led to legal action by two hedge funds, trained the spotlight on the LME and its practices, and ultimately precipitated reforms by the Hong Kong Exchanges and Clearing-owned market that are ongoing today.

These reforms have addressed various exchange functions including the reporting of over-the-counter (OTC) positions, circuit-breakers and thresholds for block trades.

In parallel, the LME has been working to modernise by upgrading its technology and increasing the use of algorithms such as Volume Weighted Average Price (VWAP) to complement the LME’s ring and phone-based markets.

Ed Meir, a senior base metals analyst at Marex, a Category one, ring-dealing member of the LME, said the exchange has moved effectively to address some of the practices that contributed to the nickel spike which forced the LME to suspend trading.

“In terms of lessons learned, the exchange has done a couple of things, some of its own doing, some on account of market developments. On its own, it has increased the transparency of positions by having its customers report their OTC positions and block trades so the LME can see how big positions are getting.”

OTC position reporting was one of the first reforms introduced, bringing the LME into line with standard procedures on larger international exchanges.

Marc Bailey, chief executive officer at Sucden Financial, also a Category one LME member, agreed: “Overall, I think they have done a good job. The OTC reporting for post-trade is in place, so they should be able to see if somebody is building a big position.”

Bailey also welcomed the work the LME has done around the application of circuit-breakers, used to suspend temporarily trading when pre-agreed limits are hit.

He said: “The introduction of the limits system was paramount so now we have a structure around that where if we hit the limit for three days in a row we close for consultation.

“So, I know now with the price at $15,000 a tonne, it can’t go above $22,000 a tonne without us sitting down and discussing the drivers behind the move. That is better than waking up in the morning and finding out it’s $100,000 a tonne. That is a massive difference.”

Bailey went on to suggest a change to the LME’s approach to circuit-breakers, however, advocating asymmetrical limits to encourage short-position taking and the delivery of metals into warehouses.

“I think, therefore, the limits should be asymmetrical with a shorter range on the upside of the market to protect the shorts and give them the confidence to deliver because that creates liquidity. I think they are missing a trick there.”

More contentious are the block thresholds proposed in a whitepaper last September.

The LME suggested “industry standard” block limit rules, meaning smaller trades in some expiries and metals would be executed on screen through the LMEselect platform. The proposal, which represented the LME's first threshold for blocks to be processed through its electronic platform, would apply to any trades smaller than ten lots on five of its most traded metals contracts – aluminium, copper, zinc, nickel and lead.

Bailey said the whitepaper “was not well received”, adding: “In OTC, if your size was below the block threshold of ten you had to put it on the order book but they have since dispensed with that idea.”

The SucDen chief said the LME proposals, which also applied to the closing auction, would have affected his firm’s ability to offer market on close (MOCs) trades and last price.

“We were getting frustrated because we moved our model to compensate for VWAP. They seem to have accepted that point, and the current thinking is that the new rules will only apply to contracts within the six VWAP windows.”

A spokesperson for the LME said: “The LME has set out a clear direction of travel with the whitepaper on market structure modernisation that we published in September. The changes that we are considering will, we believe, enhance liquidity on our market, ensuring it remains robust and future-ready. We are confident that the planned measures will lead to better outcomes for the market as a whole and will bring greater cost effectiveness for end users.”

The LME spokesperson said the next step is a consultation on the feedback from the whitepaper: “In the first half of the year the full details of the measures will be put forward and formally consulted on and we will set out a timetable to ensure they are rolled out in the best possible way with minimal operational impact.”

The LME reforms then are ongoing but the anger at the nickel closure has faded over time, as evinced by the recovery in LME nickel volumes.

LME nickel traded 16.8 million lots in 2021, according to FOW Data, followed by 12.1 million lots in 2022 when the market was closed for a week, 10.4 million contracts in 2023 and 16.7 million lots last year, meaning last year was on par with the pre-nickel closure year of 2021.

Meir concluded: “There was some controversy about how the exchange handled it but if they had not done what they did, half the members of the exchange would have gone bust - there’s no way they could have paid the massive margin calls that was demanded of them in such a short time.

“Lessons have been learned and the exchange’s position has been vindicated in the courts, which is good to see,” Meir added.