These extreme (shutdown) events are
always about preserving the integrity (survival) of the market itself, rather than 'protecting' the 'guilty', which there's been some chatter on these threads about. Don't worry, Tsingshan won't escape from this scott free... not by a long shot.
Also, as general comment (i.e. not aimed at anyone specifically), I understand the deep hatred some retails might have for 'filthy shorters', but punters should understand that futures markets are quite different to equity (stock) markets.
Every single Open Position (a defined term) on a futures exchange is made up of 1 x long position
and 1 x short position. It's a zero-sum game.
In futures markets, without short positions there can be no futures contracts. Ergo, no short positions = no futures market and no capacity for producers and industrial consumers to hedge and manage risk (the fundamental reason for futures existence in the first place). People should educate themselves about how futures markets work before getting cranky about shorters in that sphere.
...
The current problem in the LME Ni complex had
nothing to do with shorting as a concept. It's a complex issue, but at its core this story is primarily (not solely) about a single whale punter (Tsingshan) having
too many short positions that they 1) had difficulty maintaining their rapidly escalating security margins and 2) never having the capacity to fulfill their delivery obligations using their (non-LME compliant) matte output from their Indonesia ops. Although their LME Ni short positions might have been seen (by some) as hedging by a producer, it wasn't. If you cannot deliver your production output to satisfy you futures contracts delivery requirements (because your production doesn't meet the exchange spec), then it's not a hedge. It's affectionately (and rather aptly) described as a
Texas Hedge -- a financial hedge that
increases risk, rather than decreasing it. Yep, it's a screwy bastardisation of risk mitigation. That's why it's called a Texas Hedge.
Tsingshan were caught out by the Russia-Ukraine saga and the associated increasing Ni prices around supply from Russia concerns (Black Swan #1). This triggered a cascasing series of events that culminated in the 145-year-old LME's history-making Ni price spike and current suspension (Black Swan #2).
Futures contracts are usually highly leveraged instruments whereby the exchange requires security 'margins' (initial security deposits) against all open positions. It's a counter-party risk management tool mandated by the exchange. All open positions are marked-to-market on a daily basis (usually). If the market moves against your open position, you will receive a margin call to stump up the equivalent amount of cash that your losing position has moved (on paper) against you. It becomes part of the security deposit held in trust by your broker to ensure no default at settlement, just in case you decide to do a runner. The margin requirements can also increase very quickly if the exchange chooses to, in order to manage increasing volatility (ouch!).
When a position is going against you (i.e. market rising for a short holder) you either find more cash to meet the margin calls, or you exit your position and close-out for a loss. You wear any hit, naturally. When you're a heavily short Blue Whale that is not
properly hedged (refer above) and you cannot meet your margin call, then your broker will start liquidating your position (i.e. buying). If liquidity dries-up, as it did on Monday, and stroke-inducing margin calls start rolling in thick and fast, panics set-in. Your broker will buy as many contracts as necessary to close-out your position, if he can find a buyer.
Remember, we're talking about a Blue Whale here who has an enormous open short position in hundreds/thousands of contracts.
If your broker cannot find buyers at given bids, he'll increase the bid until he can. Imagine what that does to price when liquidity has dried-up, as it did during Monday's Asian session (i.e. the overnight session when viewed from London).
Now imagine the guys (traders/brokers) charged with managing the account in London waking up on Monday morning (their time) to the smell of smoke because their (client's) hair was on fire (aka waking up to an reality-challenging overnight gap up). You wake up
very quickly! And you act! You bid. You bid like your life depends on it because it does -- well, your financial life, anyway. You see, as the trader/broker, you're on the hook at settlement for any losses that your client cannot cover. But this? This is... well... indigestible for any individual broker anywhere on this planet. Their employer is next in the line of liability at settlement. But it's still far too big for them to cover. The exchange is next in line to make good at settlement and this is the end of the liability line at settlement .
You're the Exchange. The problem is of sufficient size that it is now your direct settlement liability:
- It's now an existential issue; one that strikes at the heart of the integrity (viability, not morals) of the market to continue operate in an orderly manner, if at all.
- What do you do?
- Make good -- assuming you have the resources to do so -- or risk the viability of the exchange itself?
- Or do you call a halt to proceedings and think about the best (least worst) way to exercise your god-like powers in order to ensure survival so the exchange can continue to offer its services for the benefit of society.
- Naturally there is only one choice. You suspend trade. It buys you time to figure out how it got to this and how to fix it. You decide that every trade that gave rise to this existential threat gets wiped. That means all of Tuesday's trading. You obtain the necessary cash margins from the likes of Tsingshan (done - phew!) anyone else on the losing side who was problematic and you set in place some limit rules (and other policies) for when trading recommences. (Why these rules didn't already exist when they already feature so prominently in so many other int'l futures exchanges is anyone's guess. Kinda like waiting for a death at a known dangerous intersection before installing traffic lights.)
- Note that Monday's dramatic trading action (and associated price gap) will be allowed to stand, as it should.
- There will be plenty of fall-out here, not least being Tsingshan. Some smaller players (speculators/players, traders and brokers) will likely go under as a result of this. Maybe even a broking house.
- Tsingshan will still be on the hook for its open short positions. The cash found and paid to the exchange to cover its mark-to-market obligations relating to its existing short positions isn't necessarily the end of it. If the NP continues to rise because of underlying supply concerns (refer Black Swan #1), Tsingshan will be tapped with more margin calls, or they may self-select and sell and take their lumps (crystallised losses), or their broker will do so for them if they fail to meet margin again. Either way, everyone knows there's a Blue Whale more likely than not looking to exit a portion of its short position... in a tightening supply environment.
- And it will be done in an trading environment that now has 1) daily 10% limit-up rules and 2) daily 1% backwardation limits.
That's basically how it works and why subsequent events surrounding trading suspension are playing out the way they are.
Robert Friedland's brilliant
"Revenge of the Miners" quote appears to have begun playing out. Bring it!
(20min delay)