The LME nickel debacle - What market changes are needed

The LME nickel debacle focuses on a number of aspects associated with derivatives trading on exchanges that need to be addressed. 

1. What should be the level of reporting by members and users to exchanges? 

There was a clear problem with reporting to the exchange. Regardless if the hedger is a large miner, this information on sizes of risk is necessary for both what is traded on exchanges and with banks OTC. Unfortunately, reporting on exchange trades is not enough if there is a significant amount of OTC positions that are not tracked. A question exists on who should have access to this information and how should it be used. 

2. Should there be position limits with these markets? 

When there is often physical delivery, there is the potential for corners and squeezes. Positions sizes must be linked to the amount of metals in warehouses that can be delivered. There is also an issue of speculative versus hedge limits and determining whether there should be hedge exemptions. This leads to the issue of whether position limits should be adjusted as contracts move close to expiration. LME faces unique issues relative to contracts on the CME.

3. Should there be daily price limits with these markets? 

The use of daily price limits is tied closely with margining. Price limits allow for some cooling off period that allows firms to gather margin money as well as assess market conditions. daily limits in nickel would have limited the nickel extremes in any given 24-hour period. 

4. What should be the relationship between exchange traded and OTC markets?

This is one of the critical issues for all futures and derivative trading especially when there are OTC products that are priced against a futures close. It is not just what is trading on the exchange but what is traded OTC but uses exchange pricing. 

All of the above are important questions. Some have already been answered by the LME like daily limits, but other structural issues need to be addressed. Market price extremes uncover problem with any market structure which now requires innovation.