It’s not just moral outrage that’s driving the solidarity among hedge funds. It’s also self interest: if Elliott is successful, it may pave the way for others to sue the LME, several hedge fund executives said.
Titans of the industry from Citadel’s Ken Griffin to AQR Capital Management’s Cliff Asness have expressed their ire at the exchange’s decision in March to cancel billions of dollars of nickel trades when prices spiked amid a short squeeze. While the LME’s intervention rescued a number of brokerages from ruinous margin calls and effectively bailed out Chinese nickel tycoon Xiang Guangda, it also wiped out the profits of other investors.
“That was one of the worst days in my professional career in terms of watching the behavior of an exchange,” Griffin told Bloomberg TV last month. “When you interfere with markets on an ex-post basis it’s incredibly destructive to the meaning of markets.”
But while many have voiced their fury, only Elliott and Jane Street — which has filed a much smaller claim for $15 million — have launched legal action against the LME so far. The two firms have filed for so-called “judicial reviews” of the LME’s role in the nickel crisis, the exchange said this week.
Under UK law, a judicial review must be initiated within three months of the actions that are the focus of the complaint. The LME suspended nickel trading and canceled trades on March 8, meaning that Elliott and Jane Street are set to stand alone as the standard-bearers for the hedge fund industry’s wrath at the LME.
“Rooting for Elliott on this one,” tweeted short seller Muddy Waters Research.
Those funds that have not filed for judicial review may not have missed the opportunity to take legal action, however. Several other hedge fund executives said they were still considering suing the LME, but that they were happy to allow Elliott and Jane Street to weather the publicity and expense of bringing a judicial review.
One fund manager said that if the judicial review establishes that the LME acted improperly, he and others would then be well-placed to sue the exchange for damages in the commercial courts.
AQR is still considering potential legal action, according to a person familiar with the company’s position, but decided not to pursue a judicial review. The Managed Funds Association, which represents more than 150 hedge funds, has lodged a formal complaint with the LME over its decision to cancel nickel market transactions.
Judicial review in the UK is a form of legal proceeding that’s used to challenge the lawfulness of decisions by public bodies. The UK government has no shareholding in the LME, which is owned by Hong Kong Exchanges & Clearing Ltd.
Still, the LME performs a regulatory role as the overseer of the world’s key metals market, and in turn is supervised by the UK government via the Financial Conduct Authority. In 2014, for example, a US judge dismissed a lawsuit against the LME on the grounds that the exchange was “an organ of the UK government” and therefore was shielded by sovereign immunity.
“Where you’ve got a private body performing a regulatory function, then it can be subject to judicial review,” said Tom Hickman, a leading public law barrister. “But you need a private law cause of action to obtain damages.”
There is precedent for companies to challenge the LME through judicial review. In 2013, when United Co. Rusal disputed the LME’s proposed changes to its warehousing rules, it brought a claim under judicial review. Initially the Russian aluminum giant was successful, and the rule changes were delayed by several months until the LME succeeded in overturning the decision on appeal.
In response to Elliott and Jane Street’s suits, the LME has said it believes they are “without merit” and will contest them “vigorously.”
Indeed, the exchange has broad powers under its rulebook to intervene in its markets. One paragraph in the rules states that: “Where the Exchange considers it appropriate, the Exchange may cancel, vary or correct any Agreed Trade or Contract.”
Another gives the LME’s Special Committee, the body that made the key decisions on the nickel market, the power to “take such steps as in their absolute discretion they deem necessary” to manage any “undesirable situation.”
“The LME’s stance to say it acted in accordance with LME rules and that its decision is lawful is as understandable as it is predictable,” said Peter Bennett, a partner at Stephenson Harwood specializing in commodity litigation.
Elliott and Jane Street are likely to challenge the process by which the LME made the decision to cancel trades. In a brief statement, an Elliott spokesperson previewed the firm’s legal arguments, saying it believes the LME “exceeded its powers” by canceling trades, or alternatively that the exchange “exercised the powers that it did have unreasonably and irrationally in particular by taking into account irrelevant factors (including its own financial position) and failing to take into account relevant factors.”
Few details about Elliott’s claim have been made public. But the $456 million it is claiming in damages may indicate the scale of its trading activity in the nickel market.
It is significant in size relative to the $3.9 billion in nickel contracts that traded on the morning of March 8, according to a Bloomberg calculation based on LME data.
The scale of suit also highlights how high the stakes are for the LME.
Elliott’s damages claim is larger than the LME’s shareholder equity of $232 million, according to its most recent accounts for the year ending December 2021. LME Clear, the clearinghouse which is also a defendant in the suits, has equity of $240 million.
Of course, the two companies’ parent HKEx is a $58 billion giant of the exchange industry. Still, the costs could be significant if Elliott were to prevail in its claim, and even more so if other hedge funds then piggybacked on its success.
Total losses suffered by those who traded on the morning of March 8 could be as much as $2.4 billion. That’s according to a Bloomberg calculation based on the difference between the average price traded of around $72,000 a ton and the price just above $27,000 where nickel began trading in meaningful volumes once the market reopened.
That exceeds the $2.2 billion that HKEx paid when it bought the LME in 2012.
(By Jack Farchy, Jonathan Browning and Mark Burton, with assistance from Alfred Cang)