How metals markets can limit future meltdowns

The trading European metals is undergoing a pending spring cleaning. A month after the London Metal Exchange (LME) suspended nickel trading and canceled operations amid an epic liquidity crisis, the Bank of England, the Financial Conduct Authority and the LME itself have launched reviews about what went wrong. They will have to substantially strengthen the framework if they are to survive the likely future turmoil.

As a key component of electric car batteries, demand for nickel of sufficient quality is likely to outstrip supply over the next decade, according to Bank of America. The pandemic, the pariah status of top producer Russia and rising energy prices, which are crippling production of metals like zinc and aluminum, are also forcing traders to deplete warehouses. The total amount of metal stocks in the LME’s global storage network fell 65% in the year to February.

Persistent imbalances will cause volatility, increasing the risk of a repeat of the March crisis. For reviews to be credible, there needs to be an open admission of what went wrong. One big problem is that LME bosses could only see a fifth of Chinese producer Tsingshan’s total short position, because the group had traded over the counter (OTC) with several banks. With better information, LME could have taken earlier action. But the reviews also have to explain why the clearing house LME Clear was slow to impose higher margin requirements even after the size of the short position was already indicated by the media.

A key step would be to ensure that the LME’s rules adjust to changes in the market, such as the incorporation into operations of nickel pig iron, which will increasingly be able to be processed into high-quality nickel. LME will also have to improve its shock absorbers. It has already made improvements, such as imposing 15% daily caps on price movements. But transparency rules need to be strengthened. The Exchange has required nickel clients to disclose their OTC positions, but that should apply to other metals as well. Finally, LME must speed up communication between its departments, such as LME Clear.

All of this would help reassure users to stay with the LME, rather than go to rivals such as the Shanghai Futures Exchange. But they will also need faith in the LME criteria, which is precisely what they just lost. LME has made few changes to its management since the debacle. The CEO, Matthew Chamberlain, will be replaced by someone from the house. It could be better to incorporate new managers and directors.

Likewise, the owner, Hong Kong Exchanges and Clearing, must guarantee to the market that LME acts in the best interests of all interested parties. If you consider that the trading metals is more trouble than it’s worth, you should consider selling it to a credible owner like the Intercontinental Exchange, or even opening the property to major banks and commodity companies through some form of remutualization.

If traders feel that a strong and lasting market is no longer possible, they could pull out. This would continue a trend that has seen the total number of circulating trades in aluminium, nickel and zinc plummet, and raise the possibility of London giving up its lead in the trading of metals to its rivals. It would also make the recent volatility of some of the most vital materials for decarbonization a headache.