Analysis: Elliott Management, Jane Street sue LME for nickel debacle

By: Shivam Kaushik
Shivam Kaushik
Shivam lives in New Delhi and loves playing with the neighborhood dogs when he isn't reading history books. He… read more.
on Jun 8, 2022
Updated: Jun 9, 2022
  • In early March, nickel prices spiked over 111% on a single day to reach historic highs of over $100,000 a ton.
  • The London Metal Exchange ceased trading and cancelled earlier trades that it deemed 'disorderly'.
  • Elliott Management is suing the LME for $456 million for what it sees as an illegal use of exchange powers.

On the 8th of March 2022, prices of nickel futures spiked over 111% and were higher by over 250% in two trading sessions reaching historic highs of over $100,000 per metric ton on the London Metal Exchange (LME).

The sudden explosion in price action resulted from a short squeeze, with banks and brokers desperately trying to unload a huge position taken by Xiang Guanga, a Chinese billionaire and Founder of Tsingshan Holding Group, one of China’s largest stainless-steel and nickel miners.

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Guanga had accumulated a big short, betting that Nickel prices would fall. Essentially, he had sold nickel forwards on the market betting the market would decline.

Nickel prices had been volatile since the beginning of the year due to a lack of pure nickel, and LME stocks declining over the past few years. Further, sanctions on Russia had limited supply in the market, with the country accounting for 17% of global production of high-grade nickel.

In the 24 hours preceding the unprecedented price action, a flurry of companies exited Russia, JP Morgan chose to remove Russia from its bond indexes, a bill was introduced in the US to ban the Russian oil trade, the US Senate passed a $1.9 trillion stimulus, and crude oil prices shot higher, triggering a surge in the physical metals market.

Guangda, reportedly not identified at the time, was required to deliver 9,000 metric tons of nickel, which Tsingshan did not possess, or come good on contracts certain to bankrupt the company. Banks and brokers rushed to close the position as losses mounted.

In response to the upheaval, the LME stated that “trading had become disorderly” and that there was a potential of igniting “systemic risk”. In the “interest of maintaining a fair and orderly market”, the LME claims to have taken unprecedented steps to cease trading till the 16th of March, and controversially cancel $3.9bn in already settled trades.

According to Vivek Dhar, CBA commodities analyst, “The best way to describe what has happened is basically a physical supply risk, with Russia being side-lined from the market, translating through to a financial market event.”

Winners and losers

The decision of the LME had two immediate effects. Firstly, Tsingshan was essentially off the hook, turning back time and reversing catastrophic losses. Teetering on the brink, brokers too were rescued from massive margin calls which threatened a deeper sell-off and wider contagion.

Secondly, the financial intuitions that had made the opposite side of the bet, found their profits evaporating in an instant.

Unsurprisingly, political undertones and cronyism were thrust into the spotlight, with the oldest and largest exchange in the world, the 145-year-old LME facing a barrage of criticism for having failed in its mandate to act as an impartial party and facilitate transparent transactions.

Matthew Chamberlain, CEO of the London Metal Exchange denies any wrong-doing or favoritism, as skeptics pointed out that the owner of the LME is the Hong Kong Exchanges and Clearing Limited (HKEX). The LME claims to not have known that a giant position was held by Tsingshan Group, because of a lack of transparency in the Over-the-Counter (OTC) market.  

In the OTC market, trades are made between parties privately, outside the exchange.

According to a note by the LME, the organization was unaware of “the existence of large short positions on the OTC market, of which the LME had no visibility prior to 8 March 2022.”

On its decision to not only cease trading but cancel transactions, Chamberlain said, “We felt the pricing that was being produced was not representative of the physical market because of what we now know is the existence of this very large short position.”

The LME claims to have been pushing for reforms for greater transparency of OTC trades.  

Judicial action

One of the world’s largest hedge funds, Paul Singer led $39 billion Elliott Management has filed two claims against two separate entities of the London Metal Exchange (LME) for $456 million in what it views as illegal activity and an over-reach of the exchange’s powers.

As per Elliott Management, the LME acted, “unreasonably and irrationally in particular by taking into account irrelevant factors, including its own financial position.”

The $456 million amount is close to the value of 9,000 tons of nickel at $50,000 per metric ton, the price that was reset after canceling trades, and not the high of $100,000.

Another leading hedge fund, AQR Capital Management is considering legal action, with the Managing and Founding Principal Clifford S. Asness tweeting, “Stealing money from market participants trading in good faith and giving it to Chinese nickel producers and their banks – who could have absorbed the losses – yea, integrity.”  He also said that the LME is “reversing trades to save your favored cronies and robbing your non-crony customers”.

Why did Elliott bet on nickel?

Nickel is an element that is used in steel manufacturing, alloys and plating, and batteries.

Nickel demand has been steadily rising, especially amid the wider energy transition story and green mandates.  In 2022, stainless steel demand was expected to increase putting pressure on Ni stocks, while supply remains tight and inventories were at historic lows.

Nickel company equities have been on a strong run in the past year, production from Indonesia was expected to decline, and demand for rechargeable batteries in China was on the rise.

Due to ESG demands on production, costs have been rising to support higher prices for the much-needed metal.

Fundamentally, the metal is expected to continue to see short supply while demand is expected to boom.

The ongoing supply disruptions due to the tanker shortage and logistical bottlenecks were exacerbated by the outbreak of the Russia-Ukraine war, leading to a deeper imbalance of demand and supply of the metal, setting the stage for a price explosion.

LME tries to restore order

Notices published on the LME website state that during the closure, the exchange worked to “assess market conditions and implemented additional operational arrangements” to facilitate a return to orderly trading.

Measures included setting price limits to act as circuit breakers if trading became frenzied. Price limits would allow an upper and lower band of only 15% on any given day, as an “extra market stabilisation mechanism”.

The LME acknowledged the importance of capturing OTC data in near real-time and has extended provisions to allow for daily reporting. However, there are “operational challenges with implementing this in the short term”.

Price fiasco

The price limits proved ineffective when re-opening the market on 16th March. With traders trying to exit the tarnished market, prices breached the 15% mark on the downside on consecutive trading days. This led the LME to issue a “disruption event.”

Source: The Wall Street Journal

The ‘disruption event’ amplified uncertainty about the price with the LME Guidance on Disruption Events stating that the exchange officials would,  “continue to publish these Disrupted Official Prices and Disrupted Closing Prices on its market data feeds. However, such prices shall not formally constitute Official Prices and Closing Prices for the purposes of contracts that are not LME Contracts.” Further, market participants are “are advised to have regard to relevant contractual terms (e.g. with their counterparties) to determine the impact that Disruption Events (and the consequent effect on LME prices) may have. The guidance in this Notice should not be relied on to assess such impact”.

Moreover, due to technical snags, the LME claims that some trades were executed below the prescribed limit on the 16th, 17th, and 18th of March, and were then canceled in accordance with the exchange’s Rules and Procedures.

With market participants already on edge, the LME was unable to provide CSPs (or cash-settled prices) at the end of trading. The world did not have ‘the price’ benchmark of nickel, at least not from the LME. Despite there being no official CSP, ‘reference prices’ were issued causing further confusion.

Price uncertainty led parties to shut down furnaces and nickel-related operations.

In April, the Financial Conduct Authority (FCA) launched an independent review to ascertain how risk management measures can be improved. For instance, the inclusion of more independent directors with experience in commodities trading is expected to be beneficial to restore confidence in corporate governance.

Select serving board members also have potential conflicts of interest, such as LME Chairman Gay Huey Evans, who is also a member of the board of Standard Chartered. Some large banks may have been facing a wave of losses until the trades were reversed.

The Bank of England (BoE) is “responsible for the supervision of LME Clear as a central counterparty”, and has also undertaken a probe in April into the exchange’s decisions.

What’s next?

The credibility of the LME has taken a huge hit, with traders exiting the exchange en masse.

Today, 8th June is the deadline to file judicial reviews against the LME. Jane Street, a quantitative trading firm has already done so for $15.3 million.

More suits may be expected by the end of the day.

The LME for its part, claims that these are “without merit” and has 21 days to file a formal response in UK courts.

In the long run

The revival of the LME looks extremely difficult adding to the exchange’s woes of losing market share to other players such as the Shanghai Futures Exchange.

An emerging trend is for producers to bypass exchanges entirely, create their own platforms, and directly sell through online auctions. As per Juerg Kiener of Swiss Asia Capital, this has already happened in a big way in the lithium market. Mines are also arranging off-take arrangements where metals can be delivered directly to the end-users.

There has been some speculation that the Chinese government may look to bail out the Tsinghshan Group but does not possess the requisite metal. Markets will be watching to see if there is any indication of such a move.

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