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LME passes 'the elephant test' in court's nickel ruling: Andy Home

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Repeats story filed on Nov. 30 without changes

By Andy Home

LONDON, Nov 30 (Reuters) -You could almost hear the collective sigh of relief at the London Metal Exchange (LME) after the London High Court dismissed claims that it acted unlawfully by cancelling nickel contracts last year.

Wednesday's judgment is not the end of the legal and regulatory action.

Elliott Associates, the U.S. fund that together with market maker Jane Street Global Trading initiated the legal action, has already said it plans to appeal.

There is also an outstanding investigation by the Financial Conduct Authority into the 146-year-old exchange's handling of the nickel market in the run-up to the March 8 suspension of trading and cancellation of trades.

But the immediate threat of paying out on $472 million of damages and opening the door to more lawsuits has passed.

Other bourses are sharing the LME's relief as the High Court case was a test of how much latitude exchanges should have in deciding whether a market has become disorderly and the actions needed to restore orderly trading.

On this point Judge Jonathan Swift and Judge Robert Bright found the LME and its chief executive Matthew Chamberlain passed what is legally known as "the elephant test".


Core to the two judges' decision to dismiss all claims against the LME was the exchange's own rule book, specifically Trading Rule 22.

This not only permits the LME to "temporarily halt or constrain trading" in a disorderly market but also to "cancel, vary or correct any Agreed Trade or Contract" where the exchange "considers it appropriate".

Those powers reside in a broader regulatory framework emanating from the European Union's MiFID II market regulations and the United Kingdom's Recognition Requirement Regulations incorporating that directive into national law.

Both explicitly allow for the cancellation of trades "in exceptional cases", which would be a fair description of last year's nickel market meltdown and the resulting threat of multiple member defaults.

Although the LME rules are not "pieces of legislation", the judges said "they have power over those who trade in the market".

Elliott and Jane Street "made a conscious decision to enter each trade, and to do so under the LME Rules", including Rule 22, they wrote in their judgement.


Who decides if a market is orderly and what that word means?

The case against the LME and its chief executive Matthew Chamberlain also rested on the decision-making process that led up to the cancellation of the two funds' nickel positions.

Neither European nor British regulations define what is meant by an orderly or disorderly market. The LME submitted to the court that "it is a matter of expert judgment based on an understanding of the particular market in question and the observation of specific market behaviour at the relevant time".

This is a case of "knowing one when you see one" or "the elephant test" in legal precedent, the judges said.

While any zoologist has no difficulty in recognising an elephant on sight, a judge would not claim to have such expertise.

Within a recognised investment exchange framework, an experienced chief executive such as Chamberlain "is more akin to a zoologist than a judge (and) can be counted on to know when he is looking at a metaphorical elephant".

Because the LME and its clearing arm LME Clear "have specialist knowledge, experience and expertise in relation to complex and technical economic issues, arising in a niche area of commercial activity," any legal review "must permit sensible latitude to decision-makers".


The funds also claimed that the LME should have known about the nickel short position held by China's Tsingshan Group and its potential impact on market dynamics when deciding whether trading had become disorderly.

Although Tsingshan and its owner Xiang Guangda had already been outed in the media as the "big short", the press coverage alone would not have provided a satisfactory basis for understanding price movement, the judges said.

Citing a report by consultancy Oliver Wyman which identified four significant nickel shorts, the judges said "it is apparent (...) that the true position was much more complex than the contemporary press reports suggested, and that the scale of the short squeeze was much more significant (and not confined to Tsingshan)".

"It would not have been useful for Mr. Chamberlain to spend time and energy seeking information that would inevitably have been incomplete and unreliable," they added.

Nor would it have affected Chamberlain's assessment that nickel trading had become irrational and disorderly on the morning of March 8.


This latest chapter in the LME's history of crisis is not closed.

But the legal weight hanging over the exchange has lightened, allowing to get on with the business of restoring confidence among users, both industrial and financial.

LME trading has been transformed by the crisis in the form of permanent caps on time-spreads and limits on intraday price movements.

The exchange is extending its regulatory oversight into the over-the-counter (OTC) shadows. The Oliver Wyman report found that a lack of transparency around OTC positions held by Tsingshan and other actors in the nickel drama was a barrier to understanding what was going on.

To boost its still flagging nickel volumes, the exchange is also fast-tracking the approval of more producer brands to help rebuild physical stock liquidity.

The cumulative reforms are intended to restore trust in the exchange's historic role as a setter of benchmark prices that determine the value of much of the world's trade in industrial metals.

On that count, the jury is still out.

The opinions expressed here are those of the author, a columnist for Reuters.

Editing by Barbara Lewis


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