Tuesday, July 12, 2022

The reason why the London Metals Exchange "blew up in March"

 

There's an old saying that if you owe the bank $1 million, you have a problem.  However, if you owe the bank $100 million, the bank has a problem.  That appears to have been behind the London Metal Exchange's unprecedented actions during March this year, when they effectively defrauded dozens, perhaps hundreds of independent traders in favor of one very large client who couldn't cover his short positions.  Matt Levine reports:


Xiang shorted something like 150,000 tons of nickel somewhere in the $20,000s, and when nickel prices went up to $100,000 he said “no thank you”:

After nickel started spiking on March 7, Tsingshan struggled to meet its margin calls. … The LME had eventually intervened to halt trading a couple of hours after nickel hit $100,000. It also canceled billions of dollars of transactions, bringing the price back to $48,078, where it closed the previous day, in what amounted to a lifeline for Xiang and Tsingshan.

And then the LME said “well, okay, $48,000?” and Xiang again said “no thank you”:

To reopen the market, the LME proposed a solution: Xiang should strike a deal with holders of long positions to close out his trade. But a price of around $50,000 would be more than twice the level at which he had entered his short position, and would mean accepting billions of dollars in losses. ...

Xiang told the assembled bankers he had no intention of closing the position anywhere near $50,000. A few hours later he was delivering the same message to Matthew Chamberlain, chief executive of the LME. Tsingshan was a strong company, he said, and it had the support of the Chinese government. There would be no backing down.

And so his banks said “well okay what price would be acceptable” and he said “$30,000” and they said “fine”:

On March 14, a week after the chaos that engulfed the nickel market, Tsingshan announced a deal with its banks under which they agreed not to pursue the company for the billions it owed for a period of time. In exchange, Xiang agreed a series of price levels at which he would reduce his nickel position once prices dropped below about $30,000. 

Eventually nickel got below $30,000 and he got out of the position at about a $1 billion loss. “The loss has been roughly offset by the profits of his nickel operations over the same period.”

The article also describes the scene at Xiang’s office on the evening of March 8:

Within hours, more than 50 bankers had arrived at his office wanting to hear how he planned to respond to the crisis. He told them simply: “I’m confident that we will overcome this.”

If FIFTY BANKERS ever arrive at your office all at once, (1) you have done something terrible but (2) it is absolutely their problem, not yours.

With unprecedented chaos rippling through the industry, Xiang — still facing his bankers in the early hours of March 9 — had a key advantage. They were more terrified than he was.

If he refused to pay, they would have to chase him in courts in Indonesia and China. What’s more, he had executed his nickel trade through a variety of corporate entities – such as the Hong Kong branch of battery unit Ruipu Energy Co. – and it wasn’t clear the banks would even have the right to seize Tsingshan’s most valuable assets.

The bankers understood that if things went wrong, their careers would be over, one person who was in the room remembered.

Incredible stuff. When the LME declared that the price of nickel wasn’t actually $100,000 (as the market said) but $48,000, it broke a bunch of trades and cost some financial traders hundreds of millions of dollars. They were really mad, understandably; several have sued the LME. I was pretty sympathetic to those lawsuits before reading this story, but now, oh man! The LME canceled trades and shut down the market not for some good neutral reason, but because it was bullied by a giant trader who decided that he preferred not to follow the rules, and the LME couldn’t risk the chaos of trying to hold him to the rules. So it put his losses on other people instead, people who did follow the rules and could meet their margin requirements.


There's more at the link.

That's the Golden Rule in operation - the financial Golden Rule, not the altruistic one.  The financial one says, "He who has the gold, makes the rules".  Xiang and his company had literally billions of dollars in short exposures, but the banks and the LME couldn't force him to cover them.  In other words, it became their exposure as much as - if not more than - his.  If he didn't cover it, they would go to the wall before he did.

As for all the other clients of LME, well, sucks to be them, I guess.  Many of them were effectively defrauded of millions, even hundreds of millions, of dollars in perfectly legitimate trades that the LME canceled in order to cover Xiang as best it could.  I hope they win their lawsuits . . . but whether they'll ever recover from the financial damage they've suffered is a dubious proposition.  Some will probably end up in bankruptcy court.

It just goes to show.  If you don't know who's really calling the shots in a business deal, it's not you.  If you don't know who has the most influence on a market, it's not you.  If you believe that any major bank, or any major exchange, actually cares about you, and is offering you services and loans so that you can grow richer, you're living in cloud cuckoo land.  They're in it for themselves;  and if it's in their best interests to favor one investor over another, they'll be all over that like white on rice, and you can go sing for your supper in the street outside.

It's not for nothing that the term "bankster" was invented.  I thought Jon Corzine was about the most egregious example of one I was likely to hear about, but Xiang looks set fair to fill his shoes, and then some.

Peter


12 comments:

Beans said...

And also shows the lack of value of any 'paper' assets. Like any precious metal certificates.

Then again, any 'hard' assets are also subject to the screwing around by governments and the big players, as many in the 1930's found when private ownership of gold was made illegal.

Nothing is safe from being screwed around.

Divemedic said...

Not when you are a part of a communist government and have its full backing and support. The Chicoms are ripping off the entire world.

Dave said...

This sounds somewhat like the Gamestop stock debacle.

But yeah, Divemedic's got it right. It never hurts to be backed by the Chicom machine.

Genji said...

@Divemedic:

As does any government and its cronies worth their salt. 2007/8 anyone?

Never hurts to be backed by a government (various PRC enterprises) or to OWN a government (take a good look at your country).

Either way, none us us posting here are in the club.

Genji said...

As I'm sure we're all aware (haha), the LME is owned by Hong Kong Exchanges and Clearing Limited (feel free to google their Wickedpedia page) and take three guesses who owns that by hook or by crook. As in the YouKnowWho's we can't mention by name don't call *all* the important shots in financial markets these days -- the Chinese get to have a say, too.

Anyway, since we're not all sentimental old Boomers here, none us us were ever so stupid as to believe in free markets and all that crap, so no sweat.

It's a Big Club and we ain't in it.

James said...

This is why my precious metal investment is in US silver coinage as I feel it is the safest way to go. Not totally safe but safest, not necessarily the best form of silver for investment purposes, but I don't do it for investment but for last ditch collapse survival. They are less likely to ban coins in circulation than various forms of non-coin silver, to say nothing of the other metals.

Mind your own business said...

So has the LME wised up and now banned this cocksucker from ever trading with them again? I'll bet they didn't.

If you keep dealing with people with no honor who don't keep their word or fulfill their contracts, you have nobody but yourself to blame when the dumpster catches fire for the second time.

Peter said...

@Mind your own business: No, the LME hasn't, for one simple reason: the LME is owned by Hong Kong Exchanges & Clearing. The Hong Kong Government is a major shareholder of the latter, and can appoint six of its thirteen directors. Guess who "owns" the Hong Kong government? Yeah, that's it - the Chinese Communist Party.

Don't expect the LME to do anything against Chinese interests, no matter what may be the laws involved. China doesn't care about other countries' laws.

Jonathan H said...

Unfortunately I'm not surprised, especially when it involves the any exchange in London.
They have a history of protecting their members.
I wouldn't be surprised if something is currently happening in silver given how large the premium is to get it in hand

kurt9 said...

I've not thought about Jon Corzine in a long time. I still think he should die a rather painful death.

Aesop said...

Poker Rules always apply:

At any table, if you cannot spot the Sucker, it is You.

Apparently a lot of "bankers" learned that rule with the LME too late.

Nuke Road Warrior said...

What's the difference between the international banking industry and mafia loansharks? The mafia uses thugs as enforcers, the banks use national armies.