The London Metal Exchange (LME) notes the FCA’s announcement today and acknowledges the findings in respect of its systems and controls. It accepts that, in March 2022, once the effects of large over-the-counter (OTC) positions had spilled over onto the LME’s nickel market, the LME price rose more quickly than would have been the case if certain LME systems and controls had acted as a better line of defence to the effects on the LME's market of the OTC disorder.
The LME also welcomes the FCA’s recognition of the fact that very large positions held on the OTC market were the principal driver of the extraordinary speed and extent of the price rises at the height of the nickel market events, and that the LME did not have visibility of the OTC positions at the time.
Since March 2022, significant work by both the LME and the FCA has materially reduced the risks of such an event from occurring again.
Firstly, in respect of the on-exchange market, the LME has implemented improvements to its control frameworks and processes, including the introduction of daily price limits. And while there is no finding by the FCA that the specific controls (including price bands) were capable of preventing the underlying market disorder of March 2022, the LME is confident that its enhanced controls and processes now in place further bolster the resilience of its markets.
Secondly, in respect of the OTC market, the LME welcomes the FCA’s recently published Policy Statement 25/1 (PS25/1) on reforming the commodity derivatives regulatory framework, and in particular the FCA’s acknowledgment that the LME could not fully assess risks in March 2022 because of a lack of visibility of OTC positions. PS25/1 provides valuable regulatory support for the LME’s own weekly OTC position reporting, which the LME felt it necessary to mandate after March 2022. PS25/1 also notes the FCA’s important power under Regulation 28 of the MiFI Regulations to intervene, including in OTC markets, where other tools are insufficient.
Matthew Chamberlain, LME CEO, commented: “We take our responsibilities as a global market operator very seriously, and acknowledge that we could have provided a better line of defence to the effects of the disorder in the OTC market, which had spilled over onto the LME market in March 2022. The LME swiftly implemented market enhancements and we are pleased to be able to move forward, stronger as a result. In parallel we fully recognise the important work the FCA continues to undertake in strengthening oversight of the OTC market."
Background
OTC
- OTC trades and associated margin calls take place outside of the LME market. They can, however, impact the LME market as OTC trades very often reference LME prices or may be hedged by positions taken on LME markets.
- As acknowledged by the FCA, this interaction between off-market OTC trades and the LME market was the largest driver of price volatility between 4 and 8 March 2022. Information about the scale of these OTC positions and associated missed margin calls is contained in the Oliver Wyman Independent Review which was commissioned by the LME, which determined that, in the days leading up to 8 March 2022, over US$1billion of OTC client margin calls had not been paid.
- The LME had previously consulted the market in 2021 on introducing additional requirements to report OTC positions to the LME, but had determined not to do so in light of concerns expressed by participants in response to the consultation that such additional requirements would duplicate similar obligations to report OTC positions to other bodies, including regulators.
- After the events of March 2022, the LME introduced weekly OTC position reporting notwithstanding market objections. In PS25/1 the FCA now states that it is appropriate for trading venues to have access to such data.
- PS25/1 also sets out further important actions which the FCA is taking in respect of oversight of the OTC market, and notes HMT’s intended modifications to the FCA’s existing powers to intervene as appropriate under Regulation 28 of the MiFID regulations. These changes would allow the FCA to intervene more effectively to require a market participant to reduce an OTC position, should it be considered necessary.
Price bands
- The LME accepts that its price bands (part of its overall systems and controls, being channels within which orders are admitted onto to exchange) could have acted as a more robust line of defence to the effects on the LME's market of the OTC disorder.
- Historically, the LME operated its price bands primarily to guard against error trades and rogue algorithms. When the price bands appeared to be inhibiting movements in price resulting from intentional trades, the LME would adjust or suspend them, in order to prioritise market price discovery.
- In respect of the events of March 2022, and given the presence of large OTC positions which were not visible to the LME, the LME’s above approach to operating its price bands allowed the LME nickel price to rise more quickly than it would otherwise have done.
- The LME is pleased to note there is no finding from the FCA that the price bands were capable of preventing the underlying market disorder in March 2022. Since March 2022, the LME has enhanced its controls including by the introduction of a daily price limit which means that LME prices cannot move by more than 12% (aluminium and copper) or 15% (all other physically settled metals).
