Another regulator said volatile commodities markets were a cause for concern, as bearish sentiment becomes more entrenched in the financial system.
Commodity market volatility could have a “disproportionately large macroeconomic impact” and spill over to the broader financial markets, said Klaas Knot, chair of the Financial Stability Board and president of the Netherlands’ Central Bank.
“We have seen in March that very volatile commodity prices may give rise to financial strains – through large margin calls, leveraged positions and concentrated exposures,” he said last week at the International Swaps and Derivatives Association’s annual general meeting.
Knot referenced the London Metal Exchange, which in March was caught flat-footed by a spike in nickel prices that led the exchange to take the unprecedented step of cancelling almost $4bn in trades. The LME is still reeling from the ensuing uproar from traders who were long nickel and lost an estimated $1.3bn of returns.
Knot’s comments come as other regulators and European authorities have also chimed in on the nickel crisis.
The chair of the European Securities and Markets Authority, Verena Ross said the nickel saga served as a “wake-up call”.
“It reminded us that in certain situations, market volatility can quickly turn into a problem to maintain orderly markets,” she said at the ISDA event.
As the Financial Conduct Authority along with the Bank of England and the Prudential Regulation Authority probe the LME’s March conduct, the exchange maintains it did not fully realise the extent of Chinese stainless steel producer Tsingshan Holding Group’s short positions, which caused a short squeeze.
The LME has told Financial News it had “limited visibility” of over-the-counter contracts, and that attempts to improve that were met with limited support. Many of Tsingshan’s short contracts were not traded on the LME but through contracts with banks such as JPMorgan, Standard Chartered and BNP Paribas.
The LME is now trying to address this issue. On 13 May, the LME put out a proposal to further enhance its visibility of OTC markets, first by revising reporting requirements for physically deliverable contracts, and in the long term by establishing an OTC position reporting framework.
The proposed changes would not be limited to nickel but a host of other metals traded on the exchange. The notice said the framework would “assist in improving future market transparency and stability”.
Regulators themselves are keen to increase market transparency throughout commodities. Lack of transparency in OTC markets for financial instruments was a major cause of the 2008 financial crisis. They are trying not to make the same mistake.
“We need to look at measures that would improve the transparency in these markets and would enable market participants and regulators to identify risks and maintain orderly markets,” said Ross.
Volatility risks abound
Nickel is not alone in suffering high volatility. Metals markets are facing a crisis, according to analysts at Goldman Sachs. The metals market is “caught between a wall of bearish Chinese sentiment, largely unimpeded Russian exports and a broad risk-off move in macro assets”, the bank said in a 15 May note.
Prior to the trading halt and cancellation, the LME had already hiked margin requirements, the amount of collateral needed to buy/hold a contract, for nickel and aluminium. As a response to the nickel saga, the LME said it could go further by ending the ability to net initial margin positions as the exchange attempts to regain confidence from market participants.
“There are a number of lessons to learn from all of that. One of those is the dangers of having large short positions and the possibility of a short squeeze. That’s not a new lesson but occasionally we forget that one,” Edwin Schooling Latter, director of market and wholesale policy at the FCA, said on 11 May.
The catalyst that cancelled transactions and suspended trading for a week in March on the LME was short positions held by Tsingshan. It held at least 150,000 tonnes of the metal short, more than what was available in LME warehouses. As nickel prices surged, Tsingshan needed to buy long positions to hedge its risk, causing prices to go up in what’s known as a short squeeze.
Schooling Latter added: “It was a reminder of the importance and the value of trading halts. It was a reminder of the fundamental importance of having robust initial margin standards; mechanism to collect new margin.”
Knot from the FSB added his concerns around market transparency do not end in the commodity markets, and that similar issues also plague cryptoassets.
“Concerns about the opacity of commodity markets, hidden leverage and the incomplete picture we have of cryptoasset markets underline the need to strengthen this foundation [of transparency]. Many of the issues in commodity and cryptoasset markets are about the interconnection of these markets with the rest of the financial system,” said Knot.
Crypto markets are continuing to reel as the collapse of a single stable coin caused shockwaves throughout the entire asset class.
To contact the author of this story with feedback or news, email Jeremy Chan