LME to almost double size of default fund as metals prices swing

The London Metal Exchange is to nearly double the size of the fund that protects the market as a whole against a sudden collapse of one of its members as the price of metals swings sharply.

A notice sent to members of the LME’s clearing house on Friday said the fund for base metals would jump from $1.1bn to $2.075bn in April “due to a rise in stress testing losses in March”.

The move marks the latest attempt by the LME to stabilise the market — which is used by metal producers and consumers globally to hedge against price fluctuations. The exchange this month halted trading in nickel for a week and was forced to cancel a day of trades after the price of the metal more than doubled.

The unprecedented volatility came after Chinese metals tycoon Xiang Guangda’s big bet that nickel prices would fall backfired as a result of the war in Ukraine. Guangda faced huge margin calls — demands for extra cash — but eventually struck an agreement with his banking counterparties including JPMorgan Chase and Standard Chartered to keep the bearish bet open and refrain from making further margin calls.

The debacle has, however, highlighted the risk that commodities traders will run into trouble as they face almost daily bouts of volatility in raw materials ranging from oil to natural gas and wheat.

Clearing houses are designed to mitigate these threats by sitting between two parties in a trade to help prevent the fallout from defaults rippling through the market. A default fund is a layer of defence as part of that protection and used if traders cannot pay all the margin they owe.

It is made up of contributions from clearing members and is reset monthly. The payment date for members will be April 4.

The LME said the increase in the size of its fund was a standard process and the decision was made in response to stress testing it had performed over the past six months.

Trading in nickel has been highly volatile since the market reopened last week, with several temporary halts. On Friday, the benchmark three-month LME nickel contract traded as high as $40,070 and as low as $34,500.

“Nickel is finally trading and remains open as it finally finds ‘a level’,” said Alastair Munro, trader at Marex.

The LME’s decision to cancel a day of trades triggered a furious backlash from hedge funds and electronic traders. The number of open positions in nickel has fallen from more than 237,000 contracts on the day trading was suspended to a nine-year low just above 206,000 on March 22, according to the most recent data from the LME. Open interest — the number of open futures contracts — has also declined across the LME’s other key contracts.

This is a trend that is being mirrored across other commodity markets including oil as traders cut back on hedging activity because of large margin requirements.

“Trading is becoming increasingly illiquid across other key metals — aluminium, copper and zinc — with investors looking to liquidate their long positions in the wake of the LME’s efforts to ease the unprecedented volatility across the complex,” Japanese bank MUFG said this week.

The Bank of England also warned that Russia’s invasion of Ukraine “has led to significant stress in a range of commodity markets”.

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