London Metal Exchange wins High Court ruling over cancelled nickel trades
On 29 November 2023, the Administrative Court handed down its judgment in the case of Elliott Associates L.P. and other and Jane Street Global Trading v The London Metal Exchange and another, in respect of the LME's decision to cancel nickel trades in response to price surges in March 2022.
Elliott and Jane Street (together, the "Claimants") had pursued judicial review proceedings against LME and LME Clear (together, the "Defendants"), as the clearing house for trades on the LME, in response to the LME's decision to cancel all nickel trades entered into on the morning of 8 March 2022 prior to the suspension (at 08:15 am) (the "Cancellation Decision"). The aggregate value of all cancelled trades was around US$12 billion.
The Court's decision contains important commentary on the latitude afforded to decision makers such as Recognised Investment Exchanges, as well as analysis of the approach to determining when a market is "disorderly", and on the status and rights of parties to cleared and non-cleared trades on an exchange.
The nickel price surge
The LME is the leading trading venue for an array of metals, including nickel. Metals are held in LME-designated warehouses but less than 1% of LME contracts result in physical delivery, with producers, traders and financial institutions taking 'long' or 'short' positions on the metals' price movements.
In early March 2022, a perfect storm of market conditions caused an unprecedented price surge in nickel by over 270% in the space of three days of trading. Exacerbated by the growing fallout of the recent Russian invasion of Ukraine, a build-up of large exposed short positions and a lack of liquidity in the market triggered a price squeeze.
Rising prices exposed market participants to growing margin calls, resulting in those participants buying more nickel to reduce their exposure, pushing prices even higher. At the close of the market on 7 March 2022, the price of nickel was US$50,000. By early on 8 March, the price had rocketed to over US$101,000.
The suspension and cancellation of trades
The LME suspended nickel trading at 08:15 am on 8 March 2022, and, at 12:05 pm, cancelled all nickel trades entered that day before the suspension took effect. The total value of the cancelled trades was US$12 billion.
The LME's justification for the suspension and cancellation was that the nickel market had become "disorderly", and participants' exposure posed a systemic risk to the broader market.
Between 4 and 8 March, participants met nearly US$16 billion in margin calls, with the growing perceived risk of some of these participants defaulting and facing insolvency.
Status of the Claimants and LME Rules
Neither of the Claimants were members nor clearing members of the LME and both traded on the LME as clients of members. Importantly, however, both had agreed to be bound by the LME's trading rules (the "LME Rules") through the trading agreements made with the relevant LME member.
In this regard, although noting that the Claimants had no contractual nexus with the LME, the Court stated that the Claimants were bound by its rules. In particular, the Court focussed on the Rule 22 of the LME's Trading Rules ("TR22"), which states that "where the Exchange considers it appropriate, the Exchange may cancel, vary or correct any Agreed Trade or Contract".
The Court observed that the LME Rules, including TR22, operated in the field of private law (specifically, the law of contract), not public law. However, the regulatory context made it necessary to interpret the LME Rules – and, in so far as relevant, the LME Clear's rule (the "LME Clear Rules") – by reference to the overarching legislation including MiFID II, as implemented in the UK by the Recognition Requirements Regulations. This regulatory context also informed the judicial review of the decisions made by the LME and LME Clear, pursuant to their respective rules.
The Claimants' case
The Claimants' case centred on the argument that the Cancellation Decision was unlawful.
First, the Claimants alleged that the Cancellation Decision was ultra vires, focussing on the interpretation of TR22 in the light of other rules and legislative materials. The Claimants also contended the decision was taken for an improper purpose; insofar as the Cancellation Decision was implemented to protect members from the risk of default, this was not the purpose for which the powers under TR22 were conferred.
Second, the Claimants alleged that the Defendants had acted in a way that was procedurally unfair, because they had failed to give the Claimants an opportunity to make representations, and/or engaged in a "one-sided consultation". The Defendants received information from members facing the risk of default, but not from those who would be disadvantaged by the Cancellation Decision.
Third, the Claimants argued that the Defendants had an unlawful approach when deciding that the nickel market had become disorderly, in that it was wrong to focus on the view that the LME nickel price had ceased to be rationally connected with the physical market, and it was wrong to have regard to the possible adverse consequences for some members in terms of margin calls.
Fourthly, the Claimants said it was irrational to cancel all trades from 00:00 am on 8 March 2022; at most, it was argued, the Cancellation Decision should have been confined to those trades after the time when the market became disorderly.
Finally, the Claimants contended that the LME's Special Committee and/or the Board Risk Committee should have been consulted on the Cancellation Decision.
The Claimants also argued that the decisions violated their right under the Article 1, Protocol 1 to the European Convention of Human Rights ("A1 P1"), concerning the peaceful enjoyment of possessions (the "A1 P1 Claims").
Mr Justice Bright and Mr Justice Swift rejected the claim on all grounds, deciding that neither the Cancellation Decision nor the related Margin Decision by LME Clear (as to which see below) was unlawful.
In giving its judgment, the Court referred to a number of "contextual features" to the claim, which are noteworthy.
1. The definition and assessment of a "disorderly market"
It was common ground between the Claimants and Defendants that the concept of an "orderly market" was important to the proper exercise of the powers given to the LME under TR22.
Noting that there is no definition of "orderly" (or "disorderly") in the LME Rules, or in legislation, the Court found that there may be a number of different definitions or tests that a reasonable Recognised Investment Exchange could adopt. These include, but may not be limited to, the IOSCO guidance and the NASDAQ definition.
On the facts of the case, given that the understanding and approach to the assessment of market disorder taken by the LME was consistent with that of IOSCO and of NASDAQ, the Court found that the Defendants' approach in reaching the Cancellation Decision was reasonable and therefore legally permissible. The Court found it unnecessary to determine whether an alternative formulation of "disorderly" (and its associates) advanced by the Claimants through expert evidence might have been preferred by some reasonable RIEs.
2. LME / LME Clear are specialist decision-makers, in a complex, technical area
The Court had no difficulty in finding that the Defendants, "have specialist knowledge, experience and expertise in relation to complex and technical economic issues, arising in a niche area of commercial activity, that are beyond the knowledge, experience and expertise of this Court".
It follows that, "The Court’s approach to review must permit sensible latitude to decision-makers with specialist knowledge insofar as the decisions reviewed either rested on or were informed by such knowledge."
In keeping with the above, the Court accepted the Defendants' submissions that the urgency of the situation on 8 March 2022 was best assessed by the Defendants.
The Court found that the market at large required clarity on 8 March 2022 as to whether the trades that morning were to stand; postponement would have meant uncertainty, which in itself would have risked destabilising the market.
4. The contractual context – "deliberate choice and consent"
As noted above, the Court found that the Claimants had agreed to contract on terms including TR22, along with other LME Rules. The Claimants, the Court found, "did not have to do this. They could have conducted their nickel trades elsewhere (including the OTC market) or they could simply have abstained. They became subject to TR22 through their deliberate free choice and consent."
The effect of this was that the Claimants, "must be taken to have understood their rights and obligations, and the limits on those rights and obligations. They must also have understood properly the powers the LME Rules and LME Clear Rules granted to the LME and to LME Clear, and the limits on those powers", including the LME's powers to cancel trades.
Ultra Vires and "proper purpose"
The Claimants' arguments on the power of the LME to cancel the nickel trades were rejected. The Court found that the Trading Rules follow the objectives identified in Schedule 1 to the Recognition Requirements Regulations and rejected the technical grounds of challenge advanced by the Claimants on this position.
On "proper purpose", the Claimants had argued that the LME’s permitted functions do not extend to protecting market participants from the consequences of bad trading decisions or to averting perceived systemic risk, particularly where the effect would be to protect some market participants at the expense of others.
The Defendants asserted that a number of options were considered on the morning on 8 March 2022 leading up to the Cancellation Decision. Under one option ("1A"), the trades would be allowed to stand, with margin requirements calculated by reference to the pricing of those trades. However, 1A was rejected because those trades were seen to reflect a disorderly market and so were not meaningful. The LME also considered that option 1A entailed the risk of multiple defaults by members in light of an analysis that showed the additional margin required would total US$19.75 billion, and that this would not make the market orderly and, if anything, it risked causing a systemic disturbance to the nickel market. The Court noted that, "We do not see how an RIE [Recognised Investment Exchange] charged with ensuring an orderly market could not properly be entitled to take these considerations into account."
Under a second option ("1B"), the trades would stand with margin calculated with reference to the 7 March 2022 closing price, which was also rejected as a result of a decision on margin calculations by LME Clear (the "Margin Decision"). It was decided that it would be inconsistent to allow the trades to stand at their agreed prices while not using those prices for margin calculations, on the basis that those prices were not meaningful and would still risk defaults by the LME's members. There was concern on the part of LME Clear that option 1B would, if pursued, also risk leaving LME Clear under-collateralised. In this latter regard, the Court found that, in view of the legal and regulatory requirements imposed on clearing houses, LME Clear, "was right to take a conservative approach". It followed that the rejection of option 1B was not "irrational" as the Claimants had alleged.
On the issue of "procedural fairness" and the LME's alleged duty to consult, the Court concluded that consultation was not expressly required under the LME Rules nor the LME Clear Rules, and it was therefore for the Defendants "to decide whether, whom and how to consult". The Court held that, in this case, there was no duty to consult the Claimants. The Court also acknowledged that the urgency of the situation was relevant when considering what investigations should have been made and the margin of discretion to be afforded to the LME and LME Clear.
The A1 P1 Claims
Whereas the trades agreed by Jane Street on 8 March gave rise to concluded contracts that constituted "possessions" for the purposes of A1 P1, the position was different for Elliott, because their trades were not fully cleared. In LME terminology, the Elliott trades were "Contingent Agreements to Trade" not "Client Contracts" (by which Elliott agreed to sell, and the counterparty Clearing Member agreed to buy, nickel).
Therefore, the Elliott trades were held not to amount to possessions for the purpose of A1 P1, notwithstanding Elliot's submissions regarding its "legitimate expectation" that its trades would be cleared and become Client Contracts in the ordinary course.
In contrast, the Jane Street trades were found to amount to a possessions for the purposes of A1 P1. However, in keeping with the finding on the lawfulness of the Cancellation Decision and the Margin Decision, the Defendants' interference in Jane Street's right of peaceful possession was found to be lawful. In this regard, the Court again placed emphasis on the fact that the Claimants had agreed to be bound by the LME Rules and LME Clear Rules as a condition of trading on the LME, and that TR22 therefore applied to Jane Street with its informed and willing consent.
Reactions and a potential appeal
Elliott has said that it plans to appeal the judgment, warning it was "concerned about the precedents that it establishes".
The LME welcomed the judgment stating that it "recognises LME's obligation to maintain orderly markets and its powers to intervene to this end, including by cancelling trades".
David Capps, Alan Ward, Jonathan Spearing, Andrew Green and Emily De Salis