LME’s inability to identify short positions key in nickel market blowout, report says | Mint

LME’s inability to identify short positions key in nickel market blowout, report says

The offices where the London Metal Exchange is headquartered are seen in the City of London. (REUTERS)
The offices where the London Metal Exchange is headquartered are seen in the City of London. (REUTERS)

Summary

  • Oliver Wyman said that the existence of large, exposed short positions was in part due to the LME’s inability to identify and address these positions as they were being built-up

The London Metal Exchange’s inability to identify and address exposed over-the-counter short positions within the nickel market was key in the market blowout of March 2022, according to an independent review of the short squeeze last year.

Management consulting firm Oliver Wyman Limited released on Tuesday its independent review into last year’s nickel meltdown, looking into the contributing factors as to why the market experienced a short squeeze which led to prices spiraling to over $100,000 a metric ton--up more than 270% in the space of three days.

A short squeeze happens when rising prices create pressure on holders of short positions by increasing their margin call requirements, pushing shortholders to shed their exposure, further accelerating the price move and forming a vicious cycle.

Oliver Wyman said that the existence of large, exposed short positions was in part due to the LME’s inability to identify and address these positions as they were being built-up. This in turn meant that the fragmentation of large positions across members and between on-exchange and OTC markets contributed to reducing the visibility of those risks.

The consulting firm also said that “regulatory position limits and the LME’s accountability levels did not prevent the build-up of these positions" and that position limits were too high to meaningfully affect trading activity.

Oliver Wyman noted that the nickel market is often known to be volatile and prone to distortion--with the market’s exposure to Russian supply a further issue--all of which in turn reduced the market’s willingness to provide liquidity. “This made participants wary of positioning on the wrong side of potential price moves," further exacerbating any underlying issues.

“The severity of the price spiral was not controlled by the LME’s price volatility controls during the events," Oliver Wyman added, saying that the dynamic and static price bands the LME employed didn’t stop the run up in prices.

“Eventually, market participants began to think that some members might be insufficiently robust to weather the events, with market rumors claiming a member had failed to pay a margin call seen by participants as adding to market pressure to reduce risk by closing short positions," the consulting firm said.

Oliver Wyman recommended to the LME that it extends the mandate of its risk and control functions to explicitly cover the identification and prevention of market distortions, and upgrade capabilities accordingly.

It also said that rules and enforcement processes should be tightened to avoid market distortions, such as adopting LME-specific position limits and revamping existing accountability level frameworks to help address risks created by large positions.

Oliver Wyman also suggested the LME should monitor significant risks in the OTC market such as requiring members to notify the LME when clients reach set materiality thresholds or when clients miss significant margin calls.

Volatility controls and readiness for extreme events should also be amped up, including “looking at developing processes with members to effectively manage client defaults on OTC as well as centrally cleared positions."

The LME welcomed the report saying it was committed to taking the necessary steps to rebuild confidence in the market. It said it would prepare an implementation plan due at the end of the first quarter.

It also said that Asian trading hours would return, though the exact date is yet to be announced, which would help reduce volatility and provide liquidity to the market.

It added it had already taken proactive steps to reduce the likelihood of similar events transpiring including “the introduction of specific tools such as daily price limits and periodic OTC reporting."

This story has been published from a wire agency feed without modifications to the text

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