MFA Piles in on LME Over Nickel Market Suspension

As well as facing two lawsuits, with more pending, over its suspension of the Nickel market and cancellation of trades in March, the London Metal Exchange has now been hit with a letter of complaint from the Managed Funds Association, on behalf of its hedge fund and alternative investment manager members.

MFA says it believes that the LME failed to perform its regulatory functions, and although the exchange’s independent review of events in the Nickel market leading to the suspension is welcomed, “MFA believes that there are a number of factors concerning the impact of LME’s actions on the market participants that must be addressed to ensure that MFA members and other market participants can continue to engage in LME markets with confidence.”

While the association does welcome the independent review, it is “an important step in regaining the trust and confidence of participants in the metals markets”, it warns as a preliminary matter that the suggested scope of the independent review set out in the LME Notice “does not address some of the points we make in our Particulars of Complaint, including the proper relationship between LME and LME Clear”.

MFA adds that as at June 8, 2022, LME has yet to make any announcement on when the market can expect the independent review to commence, or any date by which the market can expect the results of the independent review.

“MFA members, and the asset management community more broadly, provide an important source of liquidity in the UK commodities markets, and the ability of MFA members to continue to trade with confidence on the LME is therefore important for maintaining the LME’s depth of trading interest,” the letter states.

In the complaint, MFA argues that by failing to apply appropriate price limits prior to the market chaos on March 8, the LME was acting outside of its regulatory functions and contrary to its obligations to maintain an orderly market.

It adds, it is concerned that LME has not acted in a manner which was compliant with the its regulatory obligations to maintain adequate systems and control and conduct its facilities in an orderly manner and so as to afford proper protection to investors;  ensure that its management body “act[s] with honesty, integrity and independence of mind”; and identify and manage conflicts of interest between the LME and its owners, so as to avoid adverse consequences for the operation of the trading venue.

LME chose to protect its affiliate rather than to protect market participants from exposures to losses on their trading books

MFA also takes aim at LME’s pre-trade controls, observing it is concerned that the inadequacy of the exchange’s pre-trade controls with respect to its Nickel markets exacerbated the market disorder which led to LME deciding to implement the suspension and trade cancellation. Specifically, it says the LME failed to effectively apply its dynamic price-banding limits and no- cancellation range (NCR) in the period prior to the suspension of trading in Nickel, pursuant to its own policies and procedures. “It should have been evident to the LME from the extreme fluctuations in the price of Nickel during trading on 7 March 2022 (the trading day prior to the date of the suspension and date of execution of the cancelled trades) that LME’s Nickel market was becoming disorderly, and it would have been appropriate for LME to have taken action on 7 March 2022 to adjust its price limits and NCRs for Nickel contracts accordingly,” MFA states.

Instead, MFA notes, LME waited until March 8 to adjust its price limits and NCRs. “Had LME taken appropriate action with respect to its price limits and NCRs on 7 March 2022, LME could have prevented the market disorder which led to the “significant price moves” on 8 March 2022 which LME has suggested as being a root cause of the trade cancellation,” the complaint states. “MFA is therefore of the view that, in failing to take timely action to apply effective price limits and NCRs to Nickel contracts, LME failed in its regulatory obligation…More particularly, MFA is of the view that LME was in breach of its obligations under Articles 18 and 20 of Delegated Regulation (EU) 2017/584 (as transposed into UK law) to employ price-collars prior to the trade cancellation.”

The trade cancellation led to legal uncertainty and unmitigated exposure in the OTC Nickel markets for many market participants, including numerous MFA members, and further exacerbated the disorder in the markets

The complaint also takes issue with LME’s decision making around the trade cancellations, arguing that it was protecting a small number of “distressed participants”, but actually impacted a “much broader range of market participants” in terms of economic losses or lost profits. “This is because, due to the retrospective nature of the trade cancellation, market participants continued to manage their Nickel contract positions on the valid assumption that transactions executed on LME Select would settle in accordance with their terms,” the complaint states. “This retrospective action by LME, therefore, left market participants in a situation where their Nickel exposures – fluctuating heavily in a volatile market – were no longer hedged, leaving those participants exposed to losses.”

Observing it is the regulatory function of CCPs to manage counterparty default risk through the maintenance of appropriately calibrated margins and default fund contributions, in accordance with the requirements of EMIR, MFA argues the inability of the “distressed participants” to satisfy margin calls made by the LME Clear – a CCP – is a risk that should have sat squarely with LME Clear.

In the event of margin calls not being met by members which were distressed participants, MFA argues LME Clear would have been able to close out those members, and apply their initial margin contributions and default fund contributions to mitigate any potential losses to other market participants. “The instigation of a default management process by a CCP is not directly linked to orderly trading in Nickel and is not an eventuality which the LME is required to take steps to mitigate,” the complaint states. “Instead, the trade cancellation led to legal uncertainty and unmitigated exposure in the OTC Nickel markets for many market participants, including numerous MFA members, and further exacerbated the disorder in the markets.

“MFA is concerned that, in performing the trade cancellation, LME was inappropriately seeking to protect its affiliate, LME Clear, and its members,” it continues. “In other words, LME chose to protect its affiliate rather than to protect market participants from exposures to losses on their trading books. In doing so, LME demonstrated favour over its affiliate and a small number of market participants which was contrary to its regulatory obligations to afford proper protection to investors, generally.”

Although it does not seek financial recompense for what it says was the LME’s failure to act “with honesty, integrity and independence of mind”, the complaint does make a series of demands that LME adjust its rules and operating procedures. It calls for swifter responses to market fluctuations with respect to the price band limits and NCRs as well as amendments to several regulations.

While the complaint is just that, a complaint, MFA also warns, “For the avoidance of doubt, the above actions sought and this complaint in general is not exhaustive, and MFA and individual members of MFA reserve their respective rights to take further and independent action against or involving the LME in respect of the matters discussed in this complaint.”