Per reporter: Wen Qiao Per editor: Lan Suying
60,000, 70,000, 80,000, 90,000, 100,000 US dollars / ton mark!
Despite 30 years of trading metals, fund manager Luke Sadrian is still stunned in the face of the recent surge in nickel. Over the course of his long career, he has once again sensed that trading on the London Metal Exchange (LME) is so risky.
From March 7 to 8, on the red ring sofa in the center of the LME hall, traders witnessed the exchange's biggest crisis in more than three decades - Lun Nickel staged an "epic short-selling" market, rumors that Tsingshan Holdings was forced short by foreign investors, and the nickel price soared by nearly 250% in two consecutive days.
The violent rise of Lun nickel was jokingly called "demon nickel crazy rise", after the price soared to a high of 100,000 US dollars / ton, LME suspended nickel contract trading on the 8th and cancelled the day's nickel trading. As of press time, the contract transaction has not been restarted.
Like many market veterans, Sadrian decided to leave given the potential systemic risks. "LME has been my livelihood for a long time, which is heartbreaking," he lamented, "given the current uncertainty, I have decided to withdraw from all LME positions, although I am still very bullish on the prospects for copper." ”
The "Daily Economic News" reporter combed and found that since 1988, this 140-year-old exchange has faced the situation of "nickel crisis" three times, what causes the price of nickel to fluctuate frequently? Why did the LME take such an intervention? What kind of backstory is reflected?
For the first time in 34 years, nickel trading was suspended
After the price of Lun nickel hit a record high, LME issued an announcement on the 8th to suspend nickel contract trading, postpone the delivery of all spot nickel contracts originally scheduled for delivery on the 9th, and cancel all nickel trading executed in over-the-counter and LME select screen trading systems at or after 00:00 UK time on the 8th.
This means that all nickel trading on March 8 was invalidated. This is the first time since 1988 that LME has suspended nickel trading. In the subsequent announcement, the LME set out two major criteria for reopening transactions: first, it is necessary to ensure the completion of the operational procedures for safe reopening; second, before reopening, it is necessary to complete the analysis of the possibility of netting long positions and short positions. As a result of not meeting the above criteria, nickel trading still did not restart on March 11.
If trading is restarted, how will the opening price of the nickel contract be defined? LME made it clear in the announcement that it plans to set a limit for all nickel direct contracts, and the upper and lower limits are expected to change by 10%, which means that the opening price will be 10% different from the closing price on March 7. However, the indicator of this upper and lower limits is still subject to further analysis by the LME. For the consideration of this indicator, as of press time, the LME has not responded to the Daily Economic News's request for comment.
In order to further enhance the market order, LME allows holders to voluntarily offset long and short positions before the re-order date, regarding the prompt date of each nickel contract.
For the LME decision, Li Xiaojia, former chief executive of the Hong Kong Stock Exchange, said in an interview with the media that this is a decision made by the LME clearing house based on the transaction clearing rules and is in line with the market trading rules.
According to reports, LME in the design of the rules, is compared with the international market OTC, the market between large households, but in terms of core protection measures, maintenance of market order and risk response, the design of the system and the mainland trading market are essentially similar, when the market is extremely volatile and disorderly, the exchange and clearing house can take risk control and maintenance of normal market order measures, so the suspension of trading in line with the market trading rules.
The LME's decision to curb an unprecedented price spike in nickel contracts and avert greater volatility in the market, a decision that Bloomberg reported received the approval of many traders. However, some long position holders have questioned that the decision to suspend trading did prevent the shorts from losing more, but in fact at the expense of the bulls.
Systemic risk
Immediately afterward, as if in response to questions, LME made a statement on its website for the decision to suspend trading. "Soaring prices pose a systemic risk to the market, generating margin calls that are much higher than in the past and increasing the significant risk of multiple defaults." The exchange wrote.
"The reason [of the suspension] is very clear, and the prices seen during the Asian time period are already out of touch with the actual situation. We must step in to ensure that the price is not pushed in a direction that is detrimental to the market and the number of participants. LME CEO Matthew Chamberlain said in an interview with Bloomberg Television.
To understand what LME calls "systemic risk," we must first understand LME's margin call system. All liquidations of LME are done through the LME Clearing House, in which the LME Clearing House requires the broker to deposit cash or "margin" every day to cover the potential loss of the client's position.
If the market pressure is larger, the price of metal futures soars is not controlled, the margin will become higher and higher, and it may be difficult for customers to raise enough cash or collateral in a short period of time to meet the margin call requirements, which will undoubtedly increase the possibility of default. At this time, brokers may be saddled with huge debts leading to bankruptcy, and LME will also face great pressure.
The memory of the "tin crisis" of 1985 is still vivid, when tin prices fell due to the economic depression, the development of tin recycling and the substitution of aluminum in packaging. The International Tin Council bought a lot of tin in the LME in order to maintain the high price of tin, but at the same time, some European and American funds that were bearish on Lensey sold tin in large quantities.
During this period, the price of Lensey fell like a roller coaster, from $25,000 to $20,000, then to $23,000, and finally plummeted to about $18,000 again. Finally, in October 1985, the International Tin Council declared bankruptcy, unable to repay the economic debts to banks and metals, resulting in billions of dollars in losses to agency brokerage firms, and LME was forced to close tin trading for up to 4 years.
In this "demon nickel soaring" incident, if the LME does not "unplug the network cable", some brokers may also face survival problems, and the exchange may be difficult to carry the pressure. "A default is a very undesirable event for customers and the market, as it will have a significant impact." Chamberlain said.
He further said that the fundamental responsibility of the LME is to stabilize the market, and the exchange has made the right decision to guarantee the long-term stability and future of the market.
"Self-help"?
Why was the decision to suspend nickel trading decided by the clearing house? What role did the Clearing House play in this incident?
On 15 June 2012, under the leadership of then "helmsman" Lee Xiao-ka, the HKEx spent £1.4 billion to bring LME, a 140-year-old, old exchange under its wing.
In a recent interview with the media, Li Xiaojia revealed a little-known detail, after the Hong Kong Stock Exchange spent $2 billion to buy LME, it spent nearly $300 million to establish an LME clearing house, and this time it was the LME clearing house that launched the corresponding mechanism to cancel nickel contract trading. Prior to this, all of LME members' clearing operations were done through London Clearing.
The LME now has a better buffer against such a situation than the tin crisis of 1985, when there was no clearing house to protect brokers from the financial collapse of the International Tin Council.
"Without mastering the liquidation, the exchange has no 'teeth' to control the market, the exchange is only responsible for matching transactions, can not control the position and whether to close the position, only the clearing house can manage these things." Li Xiaojia explained that when the Hong Kong Stock Exchange purchased LME at that time, it had formulated a clear follow-up plan, that is, to establish a clearing house and let all members classify the clearing business to the LME, which was a strong series of reform combinations to ensure the anti-risk ability of the LME and ensure that the LME had the ability to cope with major fluctuations in the market.
It can be seen that the LME clearing house plays a crucial role in the anti-risk ability of LME. The Lun Nickel Shortfall Incident is the biggest crisis that LME has encountered again in more than three decades, and in view of the potential systemic risks, in the eyes of some investors, the suspension of the market is also regarded as LME's self-help.
On the other hand, from the financial data disclosed on the LME's official website, in 2018, LME's revenue and other revenues were about $93.4 million, an increase of 2% year-on-year. In 2019, this figure was about $98.54 million, up 6% year-over-year. By 2020, that number is about $102 million, a year-over-year increase that narrowed to 4 percent from the previous year.
In addition, the reporter inquired into the financial report of the Hong Kong Stock Exchange and found that the average daily trading volume (ADV) of LME charged metal contract transactions has declined for several consecutive years. In 2019, the number of charge metal contract trading ADV (excluding administrative transactions) was 617,000 lots, down 2% year-on-year. In 2020, it was about 571,000 lots, down 7% year-on-year. In 2021, it will be about 547,000 lots, down 4% year-on-year.
If nickel price volatility continues to lead to crashes, coupled with the pressure of declining trading volumes year after year, LME may face great challenges.
From a competitive perspective, LME faces a pinch from the Shanghai Futures Exchange and the Chicago Mercantile Exchange (CME). According to Reuters, as industrial activity began to recover in the second half of 2020, the volume of transactions in the previous period of 2020 soared, but in contrast, LME trading volume fell sharply. In addition, on cobalt and lithium contracts, LME and CME have also formed fierce competition.
However, for the "self-help" statement, Chamberlain said that the series of decisions made by the LME are not considered from the perspective of the LME itself, and the LME is not at risk.
Why are "nickel crises" so frequent?
The "demon nickel boom" is shocking, but not without precedent.
As early as 1992, Reuters financial columnist Simon Clow described it in his book The International Nickel Trade, "LME (nickel) contracts have been criticized as illiquid, unrepresentative, easily manipulated and volatile." ”
In 1988, Lun Nickel soared 50 percent during a 5-minute ring-trading session, rising from $10,000 to $15,000. By the standards of the time, this increase was about equal to the current nickel price rising to about 101365 dollars. At the time, traders protested publicly, nearly causing physical clashes that forced LME to stop trading briefly.
Turning the hand back to 2007, LME was also facing another "nickel crisis" at that time, when Lun Nickel hit an all-time high of $51,800/ton, and the shorts suffered so much losses that LME had to change the borrowing rules and classify several dominant small long positions as one entity.
"LME has had a devilish history since it launched its nickel contract in 1979," a Reuters commentary read, adding that the root cause of repeated market disruptions has not changed, with the common theme throughout the three nickel crises being low inventories at LME and even the difficulties faced by some leading nickel manufacturers who wanted to deliver physical metals to close their positions.
LME's nickel stocks have been declining since the beginning of the year. As of March 4, the total open tonnage of nickel available for physical settlement was only 36,654 tons. The LME position report shows that more than half of this is in the hands of an entity, but the report does not clearly identify the entity.
On the other hand, behind the crisis is also the deliverability of nickel itself.
"Critics say part of the problem is related to the structure of the contract," Crowe wrote, "and only a small fraction of the nickel produced each year is eligible for LME contract delivery, and LME inventories make up only a tiny fraction of global production." ”
This problem still exists today. According to the regulations, only Class 1 nickel (nickel with a purity greater than 99.8%) is eligible for LME contract delivery. About half of the world's nickel is less refined class 2 nickel - such as nickel pig iron, nickel sulfonium, nickel iron, nickel sulfate.
Therefore, when the price is abnormal, it may be difficult for the company to "escape" through physical delivery. For example, Tsingshan Holdings' nickel production does not include Class I nickel, which is why the company was faced with insufficient spot delivery.
Since the introduction of the nickel contract, the issue of nickel deliverability has been hanging over LME. In the 1990s, the industry discussed the disconnect between exchange and supply chain pricing, but ultimately found that it was impossible to find the perfect delivery standard for highly variable metals, such as nickel iron purities between 20% and 40% and a wide range of iron content.
"In the wake of this chaos, LMEs need to think about how to manage the nickel market, and the nickel market needs to think about how to deal with its pricing risk." Reuters' review article concluded.
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