The venerable 148-year old London Metal Exchange (LME) has just made it into the history books for the wrong reasons by becoming the first British trading exchange to be fined by a regulator.
The Financial Conduct Authority's (FCA) imposition of a 9.2 million pound ($11.9 million) penalty draws a line under the 2022 nickel crisis, which resulted in the eight-day suspension of the LME nickel contract and the controversial decision to cancel trades.
It could have been much worse had the LME, owned by Hong Kong Exchanges and Clearing Ltd (0388.HK), not successfully fought off claims for far higher sums in the courts.
The original penalty was set at 14.7 million pounds, equivalent to 10% of exchange revenue, but reduced for mitigating factors and early acceptance of the FCA's findings.
So what went so wrong?
In essence, the LME disconnected one set of brakes on its runaway nickel market and seemed unaware that it had a back-up set.
"IT'S DECIDED BY THE MARKET...NOT US"
That's how one of the hapless Hong Kong Trading Operations team explained to the FCA the decision to suspend price bands on three-month nickel as the price rocketed on the morning of March 8, 2022.
Dynamic price bands were the LME's primary defence against extreme market volatility. Or they were supposed to be.
In practice, the exchange saw them as little more than a control measure against "fat-finger" trades and rogue algorithms, the FCA found.
Bombarded with messages from traders complaining their nickel trades were being rejected by the LME's electronic system for being outside of the dynamic price bands, the two-man Asian-hours Operations Team decided to switch them off.
To be fair, the market was moving so fast the team had exhausted its repertoire of manual adjustments to the price bands.
Moreover, it would not be the first time the bands had been turned off to allow genuine trades into the system during periods of heightened volatility.
It had happened in both copper and tin markets in 2021. And it had happened the day before when the much larger London team had suspended the nickel bands "a number of times", according to the FCA report.
Also, no-one seems to have mentioned to the Hong Kong team that nickel was in danger of becoming a disorderly market. Nor was there any protocol as to what to do if it become so in Asian trading hours.
So they made an on-the-spot call that the best thing would be to "let the market decide (where) to go next," in the words of one team member interviewed by the FCA.
Freed of any exchange brakes, the market did just that, exploding from $60,000 to $101,365 per metric ton in the space of 80 minutes.
Cue emergency meetings in London, the suspension of trading and the cancellation of all trades made after midnight London time.
EMERGENCY BRAKES
The disconnect between LME Trading Operations team and senior management was such that, according to the FCA, those dealing with the crisis only became aware that the price bands had been suspended on March 9, the day after the market was suspended.
Moreover, everyone apart from the Trading Operations team seems to have forgotten that there was a second set of brakes that could be applied in the form of static price bands.
These were supposed to work in tandem with dynamic bands to prevent structural volatility. They were introduced by the LME at the same time in 2017 but never made it into the manual until 2021. The LME never told anyone about them, including the FCA, or how they were set. At a ratio of 5:1 to the dynamic bands, as it happens.
Except that the Hong Kong Trading Operations team had already expanded nickel's static band to $6,000 the day before, meaning the ratio had widened to 13:1.
Then they turned it off altogether on March 8 because "due to technical constraints" it was impossible to suspend dynamic bands without doing the same for the static bands.
The market's volatility controls were disabled at precisely the time they were most needed.
Moreover, even as nickel was building upside momentum on March 7, senior management failed to question "how the price could have risen by 60%, bringing the orderliness of the market into question, if the static price bands were functioning as intended," the FCA noted.
FREE MARKET OR FREE-WHEELING?
The LME was swift to introduce daily price limits in the wake of the nickel crisis and now also provides a full run-down of volatility controls on its website.
It has also begun over-the-counter position reporting to address the other major cause of the nickel debacle, namely the lack of transparency around big short positions in the market at the time.
It's not the first time the LME has emerged stronger from crisis. There was the Tin Crisis of 1986, which led to the introduction of clearing, and the Copper Crisis of 1996, which generated the first major regulatory overhaul of the exchange.
This is how this particular London institution evolves, in a succession of violent fits and starts.
The underlying pattern is one of a trading forum that has always prided itself on its free market traditions colliding with modern financial market reality.
The Hong Kong Trading Operations team's defence of its decision to switch off the price bands to allow the market to decide would have warmed the hearts of the LME's Victorian founders. But today's regulator has evidently taken the view that the LME's handling of the nickel crisis was more free-wheeling than free market.
(The opinions expressed here are those of the author, a columnist for Reuters.)
