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Treasury lessons from LME nickel turmoil


On 4th May, auto giant Volkswagen bragged to shareholders about a €3.8 billion fair value gain in commodity hedges during the first quarter of 2022.

by Nicholas Dunbar

Published: June 15th 2022

On 4th May, auto giant Volkswagen bragged to shareholders about a €3.8 billion fair value gain in commodity hedges during the first quarter of 2022. The company was less candid about its exposure to the London Metal Exchange, which came close to disaster just six weeks before VW announced these results. 

According to its 2021 annual report, VW had €2.9 billion of notional nickel hedges in place. Sources say that a considerable amount of this was placed with the LME, as well as large banks that dominate over-the-counter commodity derivatives. Skyrocketing commodity prices have highlighted the importance of such hedging intermediaries that treasurers rely on as counterparties for trades like VW’s. 

According to the minutes of the 5 May Federal Reserve Open Markets Committee meeting, released on 25 May, “the trading and risk-management practices of some key participants in commodities markets were not fully visible to regulatory authorities”. 

That’s an understatement given the turmoil of March, when the LME shut down trading in nickel after Chinese nickel producer Tsangshan Holding Group was unable to pay margin calls to JP Morgan and other OTC derivative counterparties. 

This could be a financial stability problem, says the Fed and it’s easy to see why looking at the balance sheets of the large banks the Fed regulates. Ten months ago, the value of physical commodities held on the balance sheets of the largest six banks had reached a record $62 billion. Meanwhile the notional value of commodity derivatives contracts at the six banks is $3.5 trillion, an eight-year high according to data compiled by Risky Finance.

JP Morgan has the largest commodity positions, with Bank of America close behind and Citigroup in third place. 

Back in February, Tsangshan took an outsized short position on nickel with JP Morgan (and other banks), as well as a smaller position on the LME, totalling about $6 billion in notional value. Meanwhile, corporates like VW took long positions in nickel, relying on counterparties to pay out on these hedges.

When prices spiked after Russia’s invasion of Ukraine, Tsangshan was unable to pay margin calls, and nickel prices almost doubled. To protect its own brokers, and its clearing arm which serves as central counterparty for trades, the LME suspended trading and cancelled $4 billion of trades. 

As JP Morgan CFO Jeremy Barnum told investors, “We were hedging positions for clients closely linked to nickel producers, who generally sell forward a portion of the coming year’s production. The extreme price movements created margin calls, which we and other banks are helping to address.” 

If Tsangshan had defaulted, JP Morgan might have faced a loss of $1 billion or more, but it managed to keep the loss to just $150 million. CEO Jamie Dimon added that the bank is now conducting a ‘post-mortem’ into the LME fiasco.

The LME itself – under regulatory scrutiny over the soundness of its central clearing platform – has criticised the role of OTC dealers in the March shutdown, and called for mandatory disclosure of positions.

In early June, hedge funds Elliott Management and Jane Street announced lawsuits against the LME, along with the Managed Funds Association, which represents hedge funds. 

The Fed seems to be most concerned about the LME, warning that “central counterparties (CCPs) needed to remain capable of managing risks associated with heightened volatility” and that margin requirements at CCPs could give rise to significant liquidity demands for large banks, broker-dealers, and their clients.

The UK Financial Conduct Authority and the Bank of England are conducting their own study into the nickel fiasco. They should consider the FOMC minutes as a warning shot from across the Atlantic to get their house in order, otherwise the Fed may push for an alternative trading venue for such strategic industrial metals as nickel. 

As for treasurers, the events serve as a reminder they should do their own risk assessments for counterparties that they rely on so much for their financial results.