By Russell Clark (formerly of Horseman Global), originally published on Capital Flows and Asset Markets
Like many commodities, nickel price has surged from the Covid lows. However this week is has spiked, effectively doubling, and briefly reached highs earlier this week of USD 100,000.
In response to this move, the LME has closed the market for nickel, and cancelled trades.
Why have they done this? Essentially this was to give time (and by cancelling trades, reduce the amount) for a major (Chinese) member to make a margin call. But in reality this was default by a member, and LME choosing not to place that member in default.
If we look at the default by Einer Aas in 2018, we can see why this is a default in all but name. When Einer Aas could not make a marign call he was bankrupted. His default waterfall is shown below. His initial margin was taken, then his default fund contribution. Value unknown, but I would estimate around €30MM. The clearinghouse then chipped in €7MM, and then there as a €107MM from the commodity service default fund. This commodity service default fund is paid by “surviving” members of clearinghouse. As every clearinghouse trade is matched, typically “surviving” members are the winners, or traders that have been on the right side of the trade.
The loss on the LME Nickel trade has been estimated at up to USD 12bn. The LME default fund (4.2 on its IOSCO CPMI disclosure) is given at USD 1bn. I don’t know if that number is entirely accurate, of if all of it can be applied to the nickel market, or is segregated by product. Clearly, there was a counterparty who could not make margin call, and if the rules had been followed, they should have been declared bankrupt, and the position sold, and any losses would be paid by LME, and then surviving members.
However, LME has cancelled trades, to reduce the price from USD 100,000 to USD 50,000, closed the market until Friday, and will limit price movements to 10% a day.
What does this mean? We know that one major counterparty should have gone bust, and is now getting a stealth bailout from the clearinghouse. Rather than asking surviving members to recapitalize, it has artificially adjusted prices to reduce their winnings. All of this has been done without consulting all members, and to the benefit of as far as we know one well connected member. As mentioned before, in 2019 large clearinghouse members recommended reforming the default waterfall.
In this new model, clearinghouses would have to put up more capital, and clearinghouse members would choose whether a bailout would occur or not. Sadly, reform has not happened, and the surviving members of the LME will pay the price.