In a judgment that will be of interest to exchanges and those who trade on them, the English High Court dismissed judicial review proceedings brought against the London Metal Exchange (LME) and LME Clear, the central counterparty of the LME, in respect of the LME’s decisions to cancel all trades in three month nickel futures (3M Nickel) made on 8 March 2022 (the Cancellation).
The judgment considers the lawfulness of the decisions taken by UK recognised investment exchanges (and their central counterparties) in times of increased volatility and dramatic price rises. Note that Elliott have indicated an intention to appeal the judgment.
Events of 7 and 8 March 2022
In early March 2022, 3M Nickel prices began to rise significantly and diverge from the rest of the metals market:
- On 7 March 2022, the price of 3M Nickel rose 69%; this was nearly five times greater than any move in the last twenty years.
- In the early morning of 8 March 2022, the price of 3M Nickel rose again by over 100% in just under 5 hours.
- At 8:15 on 8 March 2022, the LME decided that the market was no longer ‘orderly’ and suspended 3M Nickel trading. At 12:15 the LME published notice of the Cancellation.
Following the Cancellation, Elliott Associates and Jane Street, who were both adversely affected by the Cancellation, brought judicial review proceedings and sought to claim damages. Neither Elliott Associates nor Jane Street were themselves members of the LME, but they traded on the exchange via LME members.
The claimants argued that the LME and LME Clear acted unlawfully in regard to the Cancellation. In particular they argued that the LME had acted beyond its powers, for an improper purpose and in an irrational and procedurally unfair manner in relation to the Cancellation. As a consequence, the claimants argued that their right to peaceful enjoyment of their possessions under the European Convention on Human Rights had been breached and sought damages on this basis.
Key findings
In dismissing the claims, the High Court found that the LME and LME Clear had acted lawfully and had not breached the claimants’ rights to peaceful enjoyment of their possessions. The Court found, among other things, that:
- The LME’s decisions were taken in accordance with its own rules which gave the LME discretion to cancel trades in the context of significant price moves. The rules also did not expressly require any consultation with LME members.
- The LME was acting with a proper purpose and taking into account relevant considerations by acting to prevent multiple defaults of LME and LME Clear members due to large margin calls as a consequence of ‘disorderly’ market prices.
- The decision makers at the LME were specialist decision-makers. In the absence of a clear cut definition of ‘orderly’, these decision-makers took a reasonable approach to defining and assessing the ‘orderliness’ of the market.
- The Court was cautious about reviewing the decision of such a specialist and questioning whether the correct inquiries were made.
- The Court acknowledged that the position of those shorting the market was the cause of the rise in prices. However, the Court did not criticise the LME for not appreciating this at the time of the Cancellation because such a factor was not part of the LME’s decision-makers’ understanding of a factor which would be relevant to whether a market was ‘orderly’.
- LME Clear’s decisions in relation to the appropriate margin calls, which contributed to the Cancellation, were not irrational. LME Clear considered relevant alternatives regarding the appropriate margin calls to make and made an assessment within the scope of the discretion that LME Clear must be allowed.
- In respect of the claim for breach of peaceful enjoyment of their possessions, Elliott’s cancelled trades were not found to be “possessions” capable of protection. This was because Elliott’s trades (unlike Jane Street’s trades) were not fully cleared. Elliott instead had “Contingent Agreements to Trade” with their counterparties but no relevant contracts of sale with a clearing member.
- Jane Street’s trades were “possessions”. However, their rights had not been breached because Jane Street had consented to be subject to the LME’s trading rules and, consistent with the rest of the findings, the LME had exercised its powers under those rules lawfully.
The above findings were underpinned by key contextual features of the LME and the events of 8 March 2022. The Court noted that the LME is a specialist-decision maker in a complex and technical area and that on 8 March 2022 the LME was faced with price rises that required an urgent response. The Court also emphasised the fact that those transacting on the LME, including the claimants, had consented to be bound by the LME’s rules by virtue of choosing to transact a LME standard contract on the LME market rather than trading with a bespoke contract over the counter.
Key Takeaways
For those involved in trading on or operating regulated exchanges in times of uncertainty, there are key lessons to take away from this case. These include:
- There is no one clear definition of an ‘orderly’ market: There was no applicable legislative definition of ‘orderly’ nor a definition in the LME’s Rules that the LME had to follow. As such, in the Court’s view a number of reasonable approaches could be taken. The Court found that the LME’s approach was reasonable and in-line with established guidance from IOSCO.
- The rules governing an exchange are critical to how it can respond in a crisis: If the relevant rules give the exchange a wide scope for discretion the English courts are likely to consider that the exchange has a wide discretion to exercise its powers; particularly in complex, technical areas where urgent crises demand a swift response. The fact that market participants have agreed to trade subject to the exchange’s rules is also evidence that they agreed to the exchange’s role as decision-maker. So, it is important for all parties trading on the exchange to be aware of the scope of the trading rules.
- Decision making processes are key: The Court focused on how the decisions made by the LME were reached, by whom and on what basis. For exchanges, it is important to have a process in place to respond to market disorder and, if possible, to record the reasoning and basis for decisions taken at the time.
