The Financial Conduct Authority (FCA) took the unusual step of issuing a statement on Friday, March 3 to announce the investigation, noting that it felt it necessary to confirm that it was doing so, given public interest in the matter.
What it said was unexpected, left some questions unanswered, and raised several more.
In its statement, the FCA noted the positive changes the LME had made since March 2022. Many of these were already in motion before the findings of a comprehensive independent review by consultancy Oliver Wyman were publicized in January.
It also praised the LME’s move to increase transparency in over-the-counter trading (OTC), where trades take place directly between two parties without the supervision of the exchange.
The FCA then dropped its bombshell, announcing the enforcement investigation into “some of the LME’s conduct and systems and controls in place in the period between January 1, 2022, and the time of suspension on March 8, 2022.”
Talk about burying the lede…
Although the word “conduct” is in the regulatory body’s name and therefore at the heart of what it does, the use of that word in this context has an implicitly negative tone, suggesting some kind of failing, including a lack of fitness or propriety. In all likelihood, the term is being broadly used to cover the exchange’s systems and controls, but it is still not a good look.
Not that the wild volatility that drove nickel prices up to more than $101,000 per tonne last March could ever be viewed in a positive light.
But the FCA made no recommendations to the LME, nor did it say what it had found in the past year during which it conducted its section 166 independent review of the exchange.
Its mention of the OTC market was a little odd in itself, because that market is the regulatory responsibility of the FCA and remains outside the LME’s remit.
This leaves the FCA’s assessment of its own accountability in the situation unclear, despite the fact that the OTC market is where a vast short position was built by several banks on behalf of Chinese nickel and stainless steel producer Tsingshan Holding Group.
Investigation aside, the other key revelation was the time period that the inquiry will examine: the nine-and-a-half-week period from the start of January 2022 until the time the nickel contract was suspended on March 8.
It does not cover the LME’s decision to cancel trades, a move made after the contract was suspended.
Without explicitly saying so, the timeframe suggests that the FCA has found the LME to have correctly assessed that the nickel market had become disorderly and that it acted accordingly. After all, the LME rulebook clearly states that, “where the exchange considers it appropriate, the exchange may cancel, vary or correct any agreed trade or contract.”
That would be good news for the exchange when it faces legal action focused on the cancellations brought by Elliott Management Corp and Jane Street Global Trading.
Interestingly, the Bank of England also reported back to the markets on its own investigation earlier on Friday. The result was a completely different story.
In a straightforward notice, the BoE, which regulates the exchange’s clearing house LME Clear, laid out what it had found, what it expected in return, and that it was appointing someone to effectively make sure any promised remedial actions were implemented and properly followed.
The FCA enforcement investigation is likely to drag on for at least another year, probably longer.
The FCA will now start what it calls ‘scoping discussions’ with the LME, which are intended to provide a clear indication of why it appointed investigators; the scope of the investigation; how the process is likely to unfold; and an indication of the likely timing of the key milestones and next steps.
It seems surprisingly late now to be starting an investigation of this kind, a year after the initial nickel incident took place.
It leaves a cloud hanging over the exchange, which has been struggling to rebuild confidence in its nickel contract and has led to the exploration of other alternatives.
