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A year after the implosion of the London nickel market, the London Metal Exchange (LME) has unveiled its “Action Plan” for reviving the contract’s flagging fortunes.
The suspension of LME nickel trading and the cancellation of trades last March has left the 146-year-old exchange with a trail of lawsuits, a regulatory investigation and a collapse in volumes.
After this week’s resumption of Asian-hours trading “the LME expects LME Nickel to gradually recover lost liquidity, driven by Asian arbitrage trading and hedging business,” it said.
Its Shanghai counterpart will be hoping so too. The Shanghai Futures Exchange nickel contract saw volumes slump by 70% last year with no recovery in the first two months of 2023.
The LME is also now planning to expand the range of nickel that can be delivered against its contract and will work with the Qianhai Mercantile Exchange (QME), also owned by Hong Kong Exchanges and Clearing HKEx 0388.HK, to launch spot contracts for other forms of nickel.
The is part and parcel of a broader reform package, including permanent price-move limits, lending caps, changes to margining and a drive to enhance regulatory oversight of the over-the-counter shadows.
MORE NICKEL
The LME only accepts high-purity Class I refined nickel against its contracts, creating “basis risks” for producers hedging other forms of nickel, according to a review of the March meltdown by consultancy Oliver Wyman.
China’s Tsingshan Group, the big nickel short at the heart of last year’s implosion, is the world’s largest nickel producer but not in a form that could be delivered against its London positions.
The physical market mismatch with the LME’s Class I contract is growing ever wider as a new wave of Indonesian supply arrives in intermediate Class II form.
As a first step the LME will fast-track applications and waive listing fees for Class I producer brands and look at including nickel powder as a deliverable shape.
The news generated a flurry of lending activity across the LME nickel curve, the cash-to-three-months contango CMNI0-3 widening from $172.00 per tonne at the Tuesday close to $192.50 at the Thursday close.
The reaction may be premature. As the LME itself concedes, the current list of 19 brands covers around 90% of the Class I market, meaning limited impact on stock levels over the short term.
More significant may be the LME’s admission it is “proactively working” with mainly Chinese and Indonesian operators to look at listing metal from new plants capable of converting intermediate materials directly into Class I form.
Tsingshan itself is likely to be a prime candidate. The company is commissioning a 50,000-tonne-per-year refinery in Indonesia and experimenting with using disused Chinese copper smelters to produce Class I nickel.
CLASS II PRICE DISCOVERY
Although Indonesian operators are closing the processing gap between refined metal and products such as matte and ferronickel, the underlying pricing gap remains problematic.
The LME has decided not to launch its own Class II contract, for now at least. A physically-deliverable product is hard to standardise given a wide spectrum of purity and co-product. A cash-settled contract would require “a robust and trusted price index” which doesn’t yet exist, it said.
QME will take up the challenge with the launch of spot trading of nickel matte and sulphate, a recognition that “successful Class II pricing will need to reflect the core role of China in these markets,” the LME noted.
QME was launched in 2018 after HKEx’s attempts to get LME warehouses opened in China ran aground.
It started trading alumina but has extended its portfolio to aluminium products, copper, natural gas and soybeans. Turnover rose by 144% year-on-year to 79.4 billion yuan in 2022, according to HKEx.
VOLATILITY AND VISIBILITY
The volatility restraints put in place by the LME in the wake of the nickel crisis will become permanent.
Daily price-move limits, currently set at 15% across the board, will be recalibrated with potential reductions to 12% in the case of copper and aluminium if a more granular approach is adopted, the LME said.
The exchange will consult on making the daily backwardation limit and deferred delivery mechanism a permanent part of the rule book with the aim of “providing confidence to all market participants that current structural low-stock environments can be appropriately navigated”.
It also proposes extending its stock reporting requirement beyond the existing “off-market” count, which captures metal stored off-market with contractual reference to LME delivery, to “eligible” stocks, meaning anything of LME quality in any LME warehouse.
The move towards greater visibility on what lies in the off-market warehouse shadows is mirrored in the LME’s drive to gather more information on over-the-counter (OTC) trading.
The LME has claimed it lacked timely information about the true size of Tsingshan’s short positions, which were structured across multiple brokers and split between both exchange and OTC markets. The Oliver Wyman report highlighted the need for greater regulatory oversight of the OTC market.
The LME has since introduced OTC position reporting but wants to enhance its powers to mitigate against a risk spill-over from the OTC to exchange-traded markets such as occurred last year.
It may not be easy.
“The LME recognises that some market participants may not be supportive of proposed changes in this area as their individual business models may benefit from these factors,” it noted.
The exchange also admitted that it “has experienced challenges” in introducing new OTC reporting rules, including “jurisdictional issues, such as with confidentiality and bank secrecy regimes, which limit the effectiveness of aggregating global OTC position data as not all client data can be provided.”
“The LME will engage global regulators on these topics including to seek legislation to mandate disclosure of client data,” it added.
It is, in other words, likely to be a long road. As will be any recovery in the London nickel market.
Until the LME’s reform package passes through the consultation stage to implementation, a revival of trading activity is largely dependent on the reopened arbitrage link with China.