The IMF weighs in onLMAO’s nickel debacle“Governancemechanisms...

The IMF weighs in onLMAO’s nickel debacle

“Governancemechanisms for the LME need to be strengthened to address conflict ofinterest”. Ft.com

The International Monetary Fund published its Global Financial Stability Report today. The latest one will make for uncomfortable reading at 10 Finsbury Square.

Aside from exploring big topics like Russia’s invasion of Ukraine, wobbly emerging markets and cryptocurrencies, the GSFR devoted some virtual ink to the recent nickel pickle at the London Metal Exchange.

The most eye-catching aside is the IMF seemingly agreeing with people like AQR Capital Management’s Clifford Asness that the LME’s decision to cancel several billion dollars worth of trades was the result of pressure from members, their banks and perhaps the LME’s parent, Hong Kong Exchanges and Clearing (HKEX).

The IMF obviously isn’t as testy as infamous screen-puncher Asness, but in its own idiosyncratic way, the GFSR doesn’t mince its words. Here is an excerpt, with FTAV’s emphasis:

While margin calls appear to have been generally orderly and not disruptive to market functioning so far, recent measures taken in markets and exchanges in response to elevated volatility in commodity prices highlight the need to examine the broader implications of such efforts. For example, commodity markets function differently than securities markets, and trading disruptions could exert significant adverse impacts on the real sector.

Exchanges and central counterparty clearing houses should also ensure the robustness and resilience of their information technology systems to withstand current trading conditions. Governance mechanisms for the LME need to be strengthened to address conflict of interest. Measures must be in place to ensure that the concentration of trading does not adversely impact free and fair markets. Supervisors and regulators should consider enhancing transparency, in both exchange-traded and over-the-counter markets, to pre-empt the build-up of concentrated positions and thereby limit financial stability implications.

For people that somehow missed the whole sorry saga, the GFSR also has a good box laying out what happened in technocratic but legible English. Here’s the FT’s own explanation.

One reason the IMF is concerned by the debacle is that it fears that if people think one of the world’s biggest commodity trading venues cannot be trusted then trading could migrate off transparent exchanges and on to murkier venues. Some more highlights from the GFSR:

Recent developments related in particular to the nickel market on the London Metal Exchange (LME) suggest that there are a number of potential lessons for policymakers to consider. While the stated objective of the cancellation of trades by the LME was to stabilise the nickel market, counterparties with long positions were put at a disadvantage.

Reportedly, large commodity traders have voiced concerns over the longer-term impact of the cancellation and price change limits on market confidence and participation. This risks a migration of exchange-traded contracts into uncleared over-the-counter derivatives, which are more opaque and do not have the same mechanisms for mitigating counterparty risks.

Disruptions in commodity derivative markets are particularly problematic at the current juncture of volatile prices and supply bottlenecks. Broadly speaking, a disruption in trading needs to balance financial stability and free and fair market objectives; the adequacy of governance mechanisms of market infrastructure institutions requires careful review from the perspective of mitigating conflict of interest; and further assessment may be required concerning the need to enhance transparency in exchange-traded and over-the-counter markets to improve the technical soundness of exchange platforms and avoid concentration of trading (with its implications on fair trade).