Getting nickel going again | Hotter on metals
There’s widespread agreement that the London Metal Exchange nickel contract is broken, but little consensus on how to get it going again.
Confidence in the contract was decimated when unprecedented volatility led the exchange to suspend it and cancel nickel trades in March 2022.
The exchange has since implemented a series of measures to maintain market order, including the promotion of greater over-the-counter (OTC) transparency for the market.
But the contract, which remains prohibited from trade submissions outside a 15% daily limit, is still closed in Asian trading hours amid concerns by the regulator about a repeat of last year’s performance if it reopens.
The LME’s actions from that period are also the subject of legal action in the English High Court and of investigations by the Bank of England, which regulates the exchange’s clearing house, and the Financial Conduct Authority, which regulates the metals exchange.
Challenges ahead for nickel trading
There’s a list of things that need to happen in order for the exchange to boost liquidity in the contract, which saw volumes fall almost 28% last year to 12.53 million lots, or around 75 million tonnes, LME data shows.
For starters, the regulator needs to give permission for trading in Asian hours to resume as quickly as possible, something the LME is keen to have happen.
The exchange also needs to re-evaluate the 15% limit on nickel within the context of collateral and daily price moves to determine if that level is still appropriate or if something else might be a better fit.
Some clearing members, meanwhile, argue that concentration margins, which they pay once the size of their own and their clients’ positions reach a certain threshold, constrain their finances and limit even further their ability to give credit, because the additional margin must come from their own accounts.
Clients are also now typically paying 1.5 to two times the required exchange margins to trade significantly less than their typical hedging requirements, and brokers often don’t have the capacity to take on trade and industry users that are looking for a home.
Some participants have suggested the prospect of allowing clients sponsored access, a kind of Category 3 membership system that would margin users at a higher level and give them direct exposure to the clearing house.
There’s the added problem that around a quarter of LME-deliverable nickel originates from Russia, which has market participants jumpy due to ongoing sanctions resulting from the country’s invasion of Ukraine.
The LME will also have to improve its technology offering, which has never been its strong suit. Electronic trading platform LMEselect still doesn’t have the technology to prevent trades from different units within the same firm from accidentally crossing each other, for example.
There’s also work to be done to reform the OTC market, where trades take place directly between two parties without the supervision of the exchange.
The LME has for many years been asking its members for greater oversight of the OTC market. It has added a new level of OTC reporting, although the exchange needs the UK regulator to back it further and make the legislative change.
Currently, the LME has no real sway to directly demand answers if it identifies something concerning in the opaque OTC market. Large participants, including producers like Tsingshan Holdings and major automotive consumers, are mainly dealing with banks in the OTC market, often without margin requirements and out of sight of the LME. Market participants say a limit on a combined OTC and on-exchange position might be a good starting point as a result.
It’s these kinds of creative solutions that the exchange and its ecosystem will no doubt have to consider if they are to improve liquidity in the nickel market.
Class one vs class two
Long before the nickel debacle of March 2022, there had been debate over whether the existing LME contract was actually the right one.
The LME nickel price is used as the benchmark price for the ‘class-one’ nickel market, the highest purity nickel products. These products take the form of full plate or uncut cathode, briquette, powder and various other shapes, but are defined by the purity of 99.8% nickel contained.
This differs from the so-called ‘class-two’ market which includes nickel mixed hydroxide precipitate (MHP), nickel pig iron (NPI), ferronickel and other nickel products that do not meet the deliverability requirements of the LME. These class-two markets historically have calculated their pricing on the basis of this benchmark price, either on a payables basis for the nickel content or as premiums or discounts.
Some participants in the market for MHP are looking for alternative pricing structures.
Fastmarkets launched a price assessment for MHP, CIF China, Japan and South Korea in October and is currently consulting on a proposal to amend its name and content specifications.
Fastmarkets also increased the frequency of its nickel sulfate pricing in October; the prices were originally launched in April 2021.
The difficulty with creating a class-two nickel contract, which many argue would be most appropriate for the growing electric vehicle (EV) market that its products supply, is that the price is largely discovered in China and Indonesia, where visibility is obscure at best and material is mainly used throughout the supply chain.
In other words, the class-two nickel market is vertically integrated into a consumer that probably doesn’t have a lot of need for a western entity to do its price discovery.
If the LME, or its peers for that matter, could have launched a class-two contract, one would already exist.
That leaves the LME with improving liquidity in its class-one contract and then looking at what else it might do.
GCH launches spot trading platform for nickel
One option includes cash settling to a class-one price like the one planned to be discovered via Global Commodities Holdings (GCH), which is launching a spot trading platform for nickel during the first quarter.
Although all forms of class-one nickel products will be tradable on the GCH platform, the published index number will only include briquette and full-plate cathodes. The minimum transaction size on the platform will be 20 tonnes, in contrast to six tonnes on the LME.
GCH is run by Martin Abbott, former LME chief executive officer, who well understands the ins and outs of the current nickel contract from his time at the helm of the exchange. Shareholders in GCH include Anglo American, BHP, Glencore and Rio Tinto, each of whom produces, plans to produce, markets or trades nickel.
According to Abbott, the LME takes a price from a highly liquid futures market and cascades it down to a less liquid physical market. In contrast, GCH takes a price from a less liquid physical market and cascades it up to a more liquid futures market, building liquidity and data as the platform attracts bids and offers.
In time, Abbott says, GCH can license the nickel index to a futures exchange which can then expand it into a tradable forward curve.
No doubt there are conversations taking place between GCH and the LME itself, as well as with CME Group, Intercontinental Exchange (ICE) and the Singapore Exchange, among others.
There remains the risk, of course, of further diluting liquidity in nickel trading — something the market desperately wants to avoid. At the same time, a cash price formed on the GCH platform may give some much-needed structure to price discovery and narrow spreads on the LME.
Time will tell. Restoring credibility and attracting the speculative and hedge fund participants who hot-footed it to the exit last year back into the nickel market remains the biggest challenge facing the LME right now.
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