The Last Look…

I am often asked why I have a problem with transparency, in certain circles there is genuine disbelief that someone in the financial markets industry could hold such a view – all I can say is just look at recent events in Nickel for yet another example of where transparency can exacerbate a problem.

Of course, I should stress that my issues with transparency are not around action – I believe every keystroke and conversation should be logged and kept – rather it is about transparency of market activity. There is no benefit, except for speculators and perhaps a few market makers, from too much transparency around what is actually happening in the market.

The Bank of England and Financial Conduct Authority in the UK have announced a joint study of events surrounding the Nickel market shutdown by LME last month. This review will look at LME’s governance and market oversight as well as other areas, but I wonder if they should also study the levels of market transparency?

The fact is, the rally (spike is probably more accurate) in Nickel prices was the result of several factors, not least amongst which was the fact that everyone knew the Chinese firm Tsingshan had a massive short position on board and was suffering. More pertinently, in the immediate aftermath of the chaos, every trade or adjustment this player made to its position was played out in the press.

There are arguments that a lack of transparency is the issue, namely that Tsingshan’s OTC trades exacerbated the problem, but this data surely exists in trade repositories? Perhaps the real problem is that other traders knew about the position because they study that data to help inform their trading, whereas the regulators, who probably do need to see this stuff, didn’t seem to have any structure in place to alert them to large positions?

Inevitably, a large, public, short position prompts other traders to pressure the upside, which intensifies the margin squeeze, and exacerbates the issue. Some have suggested that these traders are in the wrong, taking advantage of a problem at another player, which is, frankly, naïve nonsense. A trader’s job is to take all the information available to them and make a decision on the direction of the market – and market positioning is one such factor to consider. Equally, it doesn’t have to be traders outright buying, they could just buy back when they have sold and hold when they buy – the market impact is reduced, but the upside pressure remains.

The problem, in my view, is that it’s much too easy to figure this out. To be clear, I am not suggesting the short squeeze was triggered by some players trying to pressure the Chinese player’s short, but once the market starting rising due to geopolitical factors, it became an increasing factor – especially when the media reported the large position.

Putting aside the question of whether the exchange should act in a manner that is clearly to the benefit of one player in a country closely associated with its owner HKEX – which I have already discussed in depth – we should not forget the shortcomings at the trading firm with the large short. Whilst it is unfair, in my view, that positions are so transparent, it’s a fact of life in these markets, so why did Tsingshan think it could get away with such a large position that would stand out. I am all for traders having confidence – without it they are struggling – but some awareness of market structure would surely give pause for thought when taking on such large risk?

Perhaps the real problem is that other traders knew about the position because they study that data to help inform their trading, whereas the regulators, who probably do need to see this stuff, didn’t seem to have any structure in place to alert them to large positions?

Defenders of transparency argue that data is often delayed, and that has some validity – depending upon how long the delay is – but the fact is some positions will just stand out. Yes, the trader should have considered this, but the data could be delayed by three or four days and such a large position would still stand out like a sore thumb, because due to the transparency in the market everyone would know there is no chance they could have cut it.

The UK authorities will conduct what they consider to be the necessary investigation and make their recommendations, but I would humbly suggest they look at this issue of transparency of positions as well as their apparent inability to monitor positions. It transcends Nickel markets, so could serve a much broader purpose.

It has been said that events in Nickel did not reflect fundamentals, but I disagree. With a few high profile (and very short-term) exceptions, markets reflect the fundamental realities – and a huge position is part of that reality, and in this case it was suffering due to a war that had been signalled. Even when things go this wrong, you can’t just walk away from the position, it has to be covered, so are other traders really expected to turn a blind eye? Imagine having to explain lower profits, or even losses, to investors or shareholders on the basis you wer helping out an unrelated firm? Not only would the job tenure be short-lived, there is a chance that is collusion!

Markets will always overreact to a degree, that is what happened here, but there was a fundamental reason why Nickel went higher – the problem was it was exacerbated by events surrounding a publicly-known position. We can argue that position limits and circuit breakers on prices will ease the problem, they probably will, but the fact remains, so much of what happened here – as in GameStop – is the result of everyone knowing other people’s positions.

colin@thefullfx.com

@ColinlambertFX