In London, you can trade commodities while the regulators sleep

For financial trading of commodities, London — along with New York and Chicago — is the world’s most important city. (Source: Bloomberg)

Being asleep at the wheel is invariably a hyperbolic cliché. But in the case of the London Metal Exchange and its regulators, it’s no metaphor; it’s a literal description of last year’s crisis in the nickel market.

In the crucial hours, overnight in London from March 7 into March 8, everyone who should have been alert, from exchange executives to British regulators and government officials, was in bed. In an era when commodity trading is increasingly a 24/7 business, regulation is still a cushy 9-to-5 job.

Now, thanks to a legal challenge, we know the inside story of the turmoil, almost minute to minute. Over three days of hearings in the High Court in London in late June, and across 649 pages of witness statements, the picture that emerged is deeply troubling. At one point, nickel prices jumped nearly 250 percent in less than 36 hours. Yet, the alarms didn’t sound loudly enough inside the LME or any regulatory body. Everyone took the price gyrations as more of a hiccup than a crisis, failing to appreciate the stress building in the market. Until it was too late. Incredibly, the exchange and its regulators let nickel trading go ahead during Asia time, but none thought it prudent to stay awake to monitor the activity. Or double check that someone else was.

Instead, the LME shut down nickel trading and canceled billions of dollars worth of contracts, so the brokers were spared the call for more collateral.

The chaos wasn’t for lack of warning. The previous day, on March 7, nickel prices shot up nearly 70 percent, prompting the LME to debate the merits of suspending trading; the UK financial regulator was informed, and the exchange’s top brass held a call with officials at the UK Treasury to bring them up to speed. Everyone who needed to know knew.

And yet, despite it, everyone in London went to bed as the market opened for Asian trading. “We will see where we stand 0800-0900 tomorrow,” Matthew Chamberlain, the exchange’s chief executive officer, wrote in an email to an unnamed official at the British regulator, the Financial Conduct Authority. It was 9:36 pm on March 7 with monitoring in the hands of a small team of junior LME employees in Hong Kong. The FCA didn’t follow up until the next day. If anyone else — say, at the Bank of England or the UK Treasury, had some concerns — they didn’t speak up either.

When Chamberlain woke up the subsequent morning at around 5:30 am in London, nickel prices were up a further 25 percent. Soon after, they shot up vertically, reaching a peak of $101,365 per metric ton, double the previous day’s closing quote of $48,078 per ton.

The case at the High Court centers on whether the LME acted properly by canceling $12 billion of nickel trades during the early hours of March 8. Billionaire hedge fund tycoon Paul Singer argues it didn’t. Important as the legal challenge is, I’m less concerned about the LME-Singer battle, and more about the regulation of the commodity markets that call London home. On top of metals like nickel, copper and aluminum, there’s oil and refined petroleum products, plus natural gas, coffee, sugar and a few other raw materials. For financial trading of commodities, London — along with New York and Chicago — is the world’s most important city.

The most extraordinary piece of information from the witness statements is how little the FCA, the Bank of England and the UK government — when they were awake — knew about the crisis as it was unfolding. On March 7, Chamberlain had a single phone call with the regulator – at his own initiative, rather than the other way around - and then a handful of emails. The FCA was sleeping at the wheel not just at night, but in broad daylight.

Reading the testimony from LME executives, it appears they didn’t think regulators were up to the job. In one passage, an exchange executive says  a former LME chief operating officer thought the regulator didn’t have a “sufficient understanding” of the metals market. In another passage, the current head of compliance and regulation at the LME caustically says the FCA was, at the peak of the crisis, asking “ridiculous” questions.

Beyond the regulatory breakdown, what clearly emerges from the case is the financial weakness of many commodity brokers, which don’t have credit lines to withstand large cash demands. At one point, the LME feared several brokers would collapse if they faced cash calls for less than $100 million each. Higher capital requirements for everyone involved in the commodity business are urgently needed — not just in metals, but in other raw materials markets in London (as well as New York and Chicago). Of course, the industry would hate to put up more money. If the exchanges don’t request the changes, the regulators should.

What the nickel crisis has revealed isn’t just that the LME was asleep at the metaphorical car’s wheel. Much worse is that everyone else in the car seems to have been dozing, too: the FCA, the Bank of England and the UK Treasury. Don’t be surprised if, sooner rather than later, the commodity car crashes.

Javier Blas is a Bloomberg Opinion columnist covering energy and commodities. Views are personal and do not represent the stand of this publication.

Credit: Bloomberg