Hedge funds have cut back positions in some markets that they fear could suddenly become difficult to transact in, following the London Metal Exchange’s decision to void thousands of nickel trades.
The LME’s move in March to cancel eight hours’ worth of trades has pushed a number of hedge funds to reassess the risk they face across their portfolios from human interference upending their positions.
The exchange stepped in to halt a squeeze on a short seller and protect other users from heavy losses after the price of nickel soared by 250 per cent in just a couple of days, to $100,000 a tonne.
Its shift provoked uproar among traders, not only because many lost out on profits but also because it left them with unhedged positions in other metals markets.
Rotterdam-based quantitative hedge fund Transtrend, which trades global futures markets and manages $6.5bn in assets, told the Financial Times that it had decided to stop trading on the LME “following the nickel debacle”. It added that this decision had led to it running smaller positions in metals than it would otherwise have held.
And Paris-based quant firm Capital Fund Management, which manages $10bn in assets, has started using radical scenarios to stress test its portfolios in the wake of the suspension of the nickel market.
In turn, CFM stopped trading Japanese government bonds a couple of months ago, because of the Bank of Japan’s dominance in that market. It also temporarily stopped taking positions on European natural gas, although it has since resumed trading.
“If the energy market gaps 20 per cent overnight, how big is the margin call” for investors globally? said CFM president Philippe Jordan. “Nickel had a big part in us looking at that.”
The LME, which is owned by Hong Kong Exchanges and Clearing, has said the move to cancel trades was necessary because the market was “disorderly”.
But US hedge fund Elliott Management has sued the LME for more than $456mn, alleging that it “acted unlawfully”, while market maker Jane Street has filed a claim seeking $15.3mn.
The Managed Funds Association has also made a formal complaint to the LME, and UK regulators have been reviewing the incident.
There are signs that the incident may have hit volumes traded on the LME, although sharp moves in commodity prices may also have been a factor. April and May this year were the two months with the lowest average daily trading volumes over the past 12 months, according to LME data.
“A number of managers have reassessed the level of risk they are taking on the LME” after the exchange’s decision led to “increased uncertainty and lower liquidity in the affected markets”, said Robert Sears, chief investment officer at London’s Capital Generation Partners.
Some funds have reduced risk on the exchange and limited their trading to more liquid, shorter-duration contracts, while other managers have stopped trading on the LME for now, he added.
However, not all managers are cutting back their bets.
Investors are “obviously more sceptical of the LME having seen the issue with the nickel market”, but they are not at the point of stopping trading on the exchange, said one senior hedge fund industry executive.
Fund managers are “frustrated, but the LME is a liquidity source. You can’t go anywhere else”, the person added.
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