The London Metal Exchange claims that $20bn of margin calls would have led to the simultaneous bankruptcy of multiple clearing houses and created systemic market risk, according to its defence against a $470mn lawsuit over the cancelling of billions of dollars worth of nickel trades in March.
In court documents detailing its case against judicial review claims filed by hedge fund Elliott Management and market maker Jane Street, the world’s largest metals marketplace said the staggering surge in initial margins — cash handed over to make a trade — had threatened to tip the LME into a “death spiral”.
The requirement for $19.75bn worth of intraday margin calls — some 10 times larger than the previous record on March 4 — came after nickel prices surged 230 per cent in one day on March 8 and threatened to cause a systemic collapse in the metals market.
Elliott Management stood to profit by hundreds of millions of dollars if the nickel trades had been allowed to stand and it claimed that the exchange acted “unlawfully” by exceeding its powers in cancelling the trades.
The LME has been criticised heavily for its decision to suspend and cancel nickel trades during the unprecedented market chaos, facing accusations that it should have acted sooner to suspend trading, which would have avoided the need to reverse trades.
The LME said in a statement on Monday: “Elliott’s and Jane Street’s grounds for complaint have no merit and are based on a fundamental misunderstanding of the situation on 8 March and the decisions taken by the LME. All the actions taken on 8 March were lawful and made in the interest of the market as a whole.”
The court documents released on Monday show that on March 7, when nickel prices almost doubled in one day, three members missed initial margin calls due for payment by 9am and margin requirements increased by $7bn, the LME still deemed the market to be orderly.
It believed there were legitimate geopolitical and macroeconomic reasons for the price increase — namely potential sanctions on large nickel producer Russia.
The historic market chaos was further stoked by a large bet on falling prices held by the world’s largest stainless steel producer, Tsingshan, in the over-the-counter market, which the LME was not aware of.
LME Clear, the clearing house for the exchange, calculated on March 8 — when prices almost doubled in frenzied trading before the market was suspended — that a minimum of $19.75bn of intraday margin calls would have to have been paid on that day.
The LME said this estimate was “conservative” because it was based on a price of $80,000 per tonne of nickel, while prices had peaked at above $100,000 per tonne.
The court documents state that “the risk was greater than appreciated: the defendants’ subsequent analysis has shown that the margin calls would have caused at least seven clearing members to go into default”.
If those members had defaulted on initial margin payments, the documents say, then LME Clear would have been forced to have taken on a large short nickel position that would have resulted in a $2.6bn loss. That in turn would have caused a cascade of clearing members defaulting as LME Clear would have been forced to seek contributions from non-defaulting members to cover the loss.
The exchange added: “This disorder presented a systemic risk to the nickel market itself and to the LME’s wider market as a whole.”
The LME has introduced several measures since the market chaos including limits on daily price movements and reporting requirements on OTC positions, some of which were opposed by market participants when the LME had previously tried to make such reforms.
Elliott Management and Jane Street declined to comment.