The decision this week by the London Metal Exchange (LME) to suspend nickel trading highlighted long-standing issues regarding speculative trading and market intervention, as the Russia-Ukraine war is shaking commodity markets and exacerbating supply shortages for key metals. While it is unsurprising, the move will have implications for companies and individuals when it comes to risk management, hedging & speculative trading against the physical positions of participants at a time of acute supply chain disruptions.
On Tuesday 8th March, the LME said it would stop the trading of physically settled nickel contracts and cancel all the nickel trades performed on that day prior to its decision. The threat of sanctions on Russian metals due to the Russia-Ukraine war had already spooked prices earlier this month. Russia is one of the world’s largest producers of nickel covering between 6% and 8% of global supply. Norilsk Nickel, the Russian nickel and palladium mining and smelting company, is the world’s largest producer of battery grade nickel. Therefore, the war has been adding pressure on already strained supply chains, pushing prices for most metals, from palladium, aluminium, gold, copper and zinc.
But further price spikes were triggered earlier in the week by what was described as panicky moves by China’s Tsingshan Holding Group, the world’s largest nickel producer, and its brokers to close large short positions that it had been building up for months before the war. A short position typically refers to the sale by a participant of a stock or product that it does not own.
This sent prices up briefly above $100,000/ton on Tuesday. When trading was suspended, the three-month nickel contract hovered around $80,000/t, up 177% since Monday, according to reports, and way above the previous all-time high of $52,000/t in 2007. According to reports, market speculation suggested that Tsingshan had a short position of around 200,000 tons of nickel, which it is not able to supply because of a lack of spot product after being squeezed out by other commodity giants such as Glencore.
Hedging physical positions
The LME’s decision to stop nickel trading was meant to bring back calm in a market gripped by the short squeeze, as commodity markets have been dominated by fears of supply shortages due to the war.
The LME, which is owned by Hong Kong Exchanges and Clearing, offers contracts which can be settled physically for metal that is stored in its licensed warehouses at key trading hubs. The physical dimension of trading activities on LME means a participant with a contract to expiry becomes de facto the owner of a physical package of metals in an LME warehouse. Conversely, a participant who had sold one must deliver the package upon the contract’s expiry.
This is what differentiates LME from other futures exchanges and makes it a crucial price reference for the industrial metals market. For this reason, the LME is also a key marketplace for producers and major industrial consumers of metal who need to hedge their physical stocks against price volatility.
In principle, price movements between the physical stocks and the exchange position would find a balance. But when prices go up sharply in a volatile market, anyone with a short position needs to pay bigger financial guarantees in the form of cash and securities, or ‘margins’, to cover possible losses. Those who fail to do so can be forced to close their position.
But many criticized LME for allowing participants to build short positions in excess of available inventories. This is particularly concerning given the growing demand forecasts for nickel by the burgeoning batteries and electric vehicle manufacturing industries. The LME contract is for high-grade metal highly sought after by car manufacturers. Nickel is also used to manufacture stainless steel.
Impact on risk talent
At the time of writing, there was still no announcement by LME that activity would resume. The LME said that it was working on a mechanism that would reduce short positions in the market before a restart. As for Tsingshan Holding Group, reports suggested that it had secured loans from local and international banks to help it meet margin calls on the LME. Margin calls are requests to provide additional funds to cover losses.
But it remains unclear what mechanisms or protocols would be put in place by LME to close these positions. One option, HC Insider understands, could be that LME makes some emergency reserves available, but whether these could match losses by Tsingshan Holding Group – estimated to up to $12bn, according to sources - remains to be seen. Another option could consist in putting in place a price movement cap of 10%. But whether this can be applied to nickel alone is also unclear. Many argue that such a policy would have to be expanded to all products on the exchange for the purpose of fair competition, including aluminium, copper and zinc.
In any case, the LME is faced with increased reputational risk to manage this crisis and ensure transparent and competitive trading in the future. In fact, this is not the first time the LME is having to intervene in trading activities. “The move does not come as a surprise,” said Premesha McDonald, Portfolio Director at HC Group’s Metals and Mining practice. She referred to LME’s decision to suspend tin trading in 1985, which pushed brokers into bankruptcy. “This type of intervention happened at least a couple of times in the commodities’ industry, not just metals. The exchanges and regulators should implement sound risk and position controls to avoid such activities and abnormal conditions in the market,” McDonald said.
“These events affect our clients and individuals who in the short to medium term are affected by the suspension of trading. But crucially, it raises questions on how the role of derivatives traders, compliance and risk teams evolve as a result. The same applies to risk management and hedging activity as new control and protocols are put in place,” she added.
Meanwhile, many are keeping a close eye on the LME’s next move and protocols. These will no doubt affect trading and in turn, the way companies manage their nickel supply portfolio in coming months as markets are impacted by unprecedented geopolitical risks. “We have engaged with many clients regarding their nickel mandates over the past two years. It will be interesting to see how they react to developments in the months ahead,” McDonald said. – FS