Metal exchanges temper volatility with visibility: more reforms to come?
The “supervolatility” in commodity prices triggered by the Russian-Ukrainian war could be prolonged – reminiscent of that seen during the oil price shock, the awakening of China as a consumer nation and the global financial crisis.
Metals could suffer.
The slow GFC recovery and COVID-19 have eroded investment in new mining production, reducing supplies even as population pressure and decarbonization drive demand. The low-carbon world is rich in metals. Prices have jumped: aluminum and zinc are up 21% year-to-date, copper 7% and nickel 57%, while lithium prices have more than doubled amid shortage of supplies.
It is in this environment that metal exchanges are most needed to provide a reliable market framework. Exchanges attract more players during periods of volatility, when spot markets are at risk of becoming dysfunctional.
The ongoing investigation by the UK’s Financial Conduct Authority and the Bank of England into nickel trading at the London Metal Exchange and the LME’s order for an independent review – following speculation that has led to a recent suspension of trade – indicate that more regulation or reform could occur.
The pressure is on
Governments – which are already stockpiling metals for use in electric vehicles and wind power – must act to regulate markets and avoid shortages, said Jeremy Weir, CEO of global trader Trafigura, at the Financial Times Commodities Global Summit in Lausanne at the end of March. Germany is moving towards gas rationing. Could critical metals be next?
Inventories remain low after a global market deficit for metals in 2021, including copper, aluminum, nickel and zinc, according to the World Bureau of Metals Statistics. Russia produces 17% of the world’s nickel, and this is now subject to geopolitical restrictions, stoking speculation.
And in early March, the market caught fire. A client of a member of the London Metal Exchange – and named founder of the largest stainless steel maker and main ferronickel producer Tsingshan – established a short position equivalent to two and a half times the 70,000 tonnes of nickel stocks available from the LME. This propelled prices by 250% in three days, forcing a market halt and leading to trade cancellations estimated by market sources at $3.9 billion.
Manufacturers of electric vehicle batteries have begun to switch from nickel to cobalt, while stainless steel users have reinforced the trend to choose ferritic grades containing chromium over austenitic grades containing nickel. Platinum prices rose as automakers sought to replace Russian palladium (found with nickel) with South African platinum, broker SP Angel reported. Nickel has reached the threshold of being considered a precious metal, priced at over $1 an ounce.
“Exchanges need to get smarter about initial margin requirements and be nimble on intraday variation margins,” said Mark Thompson, director of UK-based Met Trading. “They need to ensure that sufficient margin is in place to protect all participants and ensure they are paid within 24 hours, suspending contracts if they are not. A level of caution is required when circuit breaker price movements are introduced and during the potential closing of overnight sessions: in volatile markets, the largest movements will occur outside normal trading hours.”
Related Content: LME Nickel Trade Stutter Confuses Physical Market
Price visibility and regulation are essential. Following last month’s hypervolatility – which led to more than a week’s suspension of electronic nickel trading, accounting for around 40% of total nickel trading – LME, a wholesale exchange, has for the first times introduced price ranges on firm contracts. Initially on nickel, these have been extended to its other physical base metals trades, which can now rise or fall by a maximum of 15% from the previous day’s close.
A controlled correction in nickel resulted and “orderly” trading resumed. The price bands by themselves do not reduce volumes and were welcomed “because they put stabilizers in the market,” LME said.
The LME has lowered its responsibility levels for nickel: OTC data must now be reported on transactions over 3,000 lots (of 6mt each), down from previous responsibility levels of 6,000 lots, which improves visibility. The exchange admitted in an April 4 memo that its “lack of direct visibility … large positions in the OTC market” contributed to the disorderly March 8 trading and acknowledged that “not all participants agreed with the company’s course of action” to manage the situation. . A market participant, troubled by canceled trades, said trading risks were lost for the Shanghai Futures Exchange (SHFE) and COMEX (CMEGroup).
However, the new regulations will now be in place for an indefinite period and the LME reserves the right to introduce further interim measures, as appropriate, to ensure market stability pending the outcome of the independent review.
It believes it should prioritize the implementation of OTC trade reporting for all LME metals, with an appropriate first step being to expand the provision of daily OTC position reporting (now implementation for nickel) to other metals.
“The LME is committed to ensuring that the actions of all participants (including the LME itself) are fully reviewed and appropriate action is taken to restore trust and support long-term health and effectiveness. market term,” CEO Matthew Chamberlain said.
Retail-focused exchanges usually already have price bands or limits in place on metal futures trading. The SHFE has exercised them since the launch of its metals contracts, to “safeguard” market participants, with tighter variations than those recently introduced on the LME. SHFE allows plus or minus 3% movement in the case of coils and rebars of hot rolled steel, copper, aluminum, gold and silver; plus or minus 4% for nickel, zinc, lead, tin and stainless steel, and plus or minus 5% for steel wire rod. However, its website says it can adjust price limits based on market risk if it sees a so-called “single market”.
The US-based CME Group, also considered a retail exchange, applies both price limits and dynamic circuit breakers, or DCBs, to prevent markets “from going too far or too fast on a specific period of time”. DCBs are designed to put impacted contracts into a pre-open state two minutes after they are triggered. The upper and lower bound for DCBs is a 10% move in one hour for CME’s COMEX and NYMEX metals markets. CME’s clearinghouse continually adjusts margins based on market volatility, while a market regulation team manages position limits for all participants. CME Group offers futures contracts on coal, alumina, aluminum, iron ore, scrap metal, copper, zinc, gold, platinum, palladium, lead, lithium, cobalt and others.
SGX – price bands only on rubber
The Singapore Stock Exchange (SGX) reported “phenomenal” trading volumes in late March, with the underlying commodities of its derivatives contracts, including iron ore and coking coal, experiencing considerable price volatility after the Russian invasion of Ukraine.
SGX has a range of tools to ensure an orderly market, and these will be applied where necessary, according to Director Will Chin, Head of Commodities. Limits may vary depending on the percentage of physical market availability a trade represents, in multiples of typical shipments, and taking into account the behaviors of market participants.
SGX’s steel commodity and steel rebar contracts are cash-settled at prices that reference physical market trading, reducing the risk of shortages in deliveries, the report said.
Market sources note, however, that iron ore and steel products can be warehoused or stored for shorter periods of time than non-ferrous metals due to the potential risk of rusting. The wide variety of grades and specifications of iron ore and coking coal also increasingly means that they are produced or shipped for specific customers’ steelmaking facilities, making them less standardized than non-metals. ferrous.
“Price discovery should be rooted in a fundamental principle of willing buyer, willing seller, and the exchange is not the arbiter of what constitutes reasonable price movement. Price limits may not be a parameter adequate for determining orderly trade, and are ineffective for primarily OTC and exchange-cleared contracts,” Chin said.
SGX operates price ranges only on its rubber contract, which is almost 100% screen-traded, considered to facilitate trading. Iron ore, the mainstay of SGX’s metals, whose volumes are increasing year on year, is traded mainly over the counter, with about 30% on screen, while its coking coal contracts are 100% of little by little.
Even before the Russian-Ukrainian war stamped its stamp of volatility on the markets, iron ore was already on a rollercoaster ride in the face of fundamental supply and demand issues tempered by COVID-19: a low of $78/mt in November 2019, it climbed to $233/mt. in May 2021 before falling again. S&P Global Commodity Insights’ Platts priced the Fe Iron Ore Index 62% at $154.65/mt dry CFR North China on April 8.
With additional reporting from analyst Lucy Tang