London Metal Exchange faces prospect of fines over nickel market chaos

The London Metal Exchange faces the prospect of hefty fines and censure after the UK’s top financial regulator launched an enforcement investigation into the company over the decision to freeze nickel trading during last year’s market mayhem.

The Financial Conduct Authority said the probe, the first such action it has launched against an exchange, would include actively monitoring the LME’s efforts to improve its conduct, controls and governance.

The investigation will also examine the conduct, systems and controls in place at the LME between the start of 2022 and March 8, when it froze nickel trades in response to skyrocketing prices. The investigation is likely to take several years and could result in a fine for the LME.

In a separate statement, the Bank of England said that it planned to appoint an independent monitor to report regularly on the progress by LME Clear, the exchange’s clearing house, to improve its governance and risk management.

Nickel prices more than trebled on a single day last March as fears of sanctions against Russia, a top exporter, collided with a bet on falling prices by Tsingshan, the world’s largest stainless steel producer. This led the LME to suspend and cancel huge volumes of nickel trades.

The trading crisis threatened to cause a wider market meltdown and has eroded confidence in the functioning of the nickel market.

The enforcement action follows a review by the BoE into LME Clear and an independent review by consultancy Oliver Wyman, which the central bank said collectively found “several shortcomings across LME Clear’s governance, management and risk management capabilities”.

The LME said it “will co-operate fully” with the FCA’s enforcement investigation and “will continue to take the appropriate steps to ensure the long-term health, efficiency and resilience of its market”. It added that it would resume nickel trading during Asian hours on March 20 in a bid to boost trading liquidity.

Chris Clark, a derivatives partner with law firm CMS, said the enforcement action was no surprise. “Following the cataclysmic events of last year, when metals prices spiralled out of control, it became clear how poor LME’s market oversight and suspension processes are,” he said.

Last April, the UK financial regulators announced they would review the governance and risk management of the exchange and its clearing house surrounding the decision to suspend and resume nickel trading.

The scope of the FCA’s enforcement investigation appears to omit the LME’s decision to cancel billions of dollars worth of nickel trades, which have become the focus of near $500mn in lawsuits by hedge fund Elliott Management and market maker Jane Street. The FCA declined to comment on why its enforcement action makes no reference to the cancellation of trades.

The LME introduced several measures in the wake of the nickel trading chaos to improve controls, such as price move limits and disclosure of over-the-counter trading, which is done outside of the exchange bilaterally between two parties.

The FCA said that it was “encouraged by the LME’s focus on increasing the transparency of OTC trading to support robust risk management in its on-exchange trading.”

Clark predicted there would be further probes of the mayhem. “The FCA’s requirement for banks to report on trading activities in metal has been in place for the last few months and certainly since the regulator’s statement in April of last year,” he said. “So it suggests that today’s action by the regulators is only the start of a process leading to strong enforcement.”