London Metal Exchange wins High Court battle over US$12 billion cancelled nickel trades

In R (Elliott Associates LP) & Anor v The London Metal Exchange & Anor [2023] EWHC 2969 (Admin), the Administrative Court dismissed judicial review proceedings brought against the London Metal Exchange (LME) and the clearing house for trades on the LME (LME Clear) in respect of the LME’s decision to cancel nickel trades following an unprecedented spike in nickel prices.

The Court held that the LME’s decision to cancel the nickel trades was not unlawful. The judgment will be of interest to financial institutions - it illustrates how the courts are willing to tailor their approach in judicial review cases to have regard to the contractual context, here the LME rules agreed to by the Claimants which provided the LME with certain powers. The case also demonstrates how it will be difficult to successfully challenge the decisions of specialist decision makers taken in response to crisis situations.

Background

Following the Russian invasion of Ukraine and the sanctions that were subsequently imposed, nickel prices rose in early March 2022. After two days of trading, the nickel price had risen from around US$28,000/ tonne to around US$50,000/ tonne at the close on 7 March 2022. By 6am on 8 March 2022, the price of nickel had spiked to over US$100,000/ tonne; a rise of over 100% in approximately 5 hours of trading.

Following the unprecedented price surge in the early hours on 8 March 2022, the LME concluded that the market had become disorderly and decided to suspend nickel trading, which took effect at 8:15am. At 12:05pm on 8 March 2022, the LME published its notice cancelling all nickel trades (Cancellation Decision). The aggregate value of the cancelled trades was around US$12 billion.

The Claimants – an investment fund and an international trader - were bound by the Cancellation Decision. Although the Claimants were not LME members and did not have a direct contractual link with the LME, they had agreed to the commercial terms of trade with LME members. LME members are obliged under the LME rules to ensure that all contracts with non-members, such as the Claimants, incorporate and are subject to the LME rules. Accordingly, the Claimants were bound by the LME rules and decisions made by the LME in accordance with those rules.

As the Court noted, whilst the LME rules operate in a field of private law, the regulatory context necessitated the LME rules to be interpreted by reference to the overarching legislation, including the Directive 2014/65/EU on markets in financial instruments, as implemented in the UK (MiFID II).

The Court's decision

The Claimants alleged that the Cancellation Decision caused them to lose net profits of approximately US$471 million. The LME is subject to judicial review when carrying out its regulated functions as a regulated investment exchange, and the Claimants challenged the Cancellation Decision, arguing that it was unlawful on a number of grounds, as set out further below. The Court rejected all the Claimants’ grounds and held that the Cancellation Decision was not unlawful.

The LME had the power to cancel the trades

The Claimants argued that the Cancellation Decision was ultra vires; in order words, the LME lacked the power to cancel the trades.

The Court held that the LME rules gave the LME the power to cancel trades. The key rule in question was Rule 22 of the LME rules, which states that "…where the Exchange considers it appropriate, the Exchange may cancel, vary or correct any Agreed Trade or Contract".

The Court further held that, as a matter of interpretation, Rule 22 should not be read down or limited by reference to other LME rules, MiFID II, or other rules and regulations submitted by the Claimants.

The LME did not exercise its power to cancel trades for an improper purpose

The Claimants argued that the Cancellation Decision was taken for an improper purpose, as 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.

The Court rejected that the LME exercised its power to make the Cancellation Decision for an improper purpose. As the LME is required to ensure an orderly market, in making its decision to cancel nickel trading, the LME was entitled to take into account the risk of multiple defaults by members and systemic disturbance to the market had it allowed the nickel trades to stand.

Procedural fairness

The Claimants argued that the Defendants had acted in a way that was procedurally unfair as they did not consult the Claimants nor afford them an opportunity to make representations to the Defendants about the Cancellation Decision.

The Court held that there was no duty for the Defendants to consult the Claimants. Consultation is not required under the LME rules, and it was for the Defendants to decide whether, whom and how to consult in relation to whether to cancel nickel trading.

Further, the Court accepted that the urgency of the situation on 8 March 2022 was relevant. Postponing the Cancellation Decision would not have eliminated the risk that LME members would have defaulted. Had the LME done so, it would have created “fresh peril”, as allowing market participants to have done business with LME members at risk of default would have had serious consequences for the market.

The Court also noted that even if consultation had taken place, it probably would not have made any difference – the Claimants would not have told the LME anything that was not already obvious to it.

The LME’s assessment of a “disorderly” nickel market was sound

The Claimants argued that the Defendants had taken an unlawful approach to determining that the nickel market had become “disorderly”, and they had failed to consider relevant factors and/or took irrelevant factors into account in making the Cancellation Decision.

The Court accepted the LME’s approach to determining that the nickel market had become disorderly, as its assessment was consistent with the IOSCO guidance and the NASDAQ definition. In circumstances where the LME rules and applicable legislation did not expressly define “orderly” or “orderliness”, the Court noted that there may be numerous definitions that would be appropriate for an investment exchange, like the LME, to adopt, which includes the IOSCO guidance and the NASDAQ definition.

The Court also accepted that the LME did not take into account an irrelevant factor by considering the adverse consequences for some LME members of margin calls. The LME was entitled to take this factor into account as it related to the LME’s concern that some members may default, which would have impacted not only the nickel market, but also the market more broadly. The courts should allow sensible latitude to decision makers with specialist knowledge where the decision is based on that knowledge.

The LME did not act irrationally

The Claimants argued that the Defendants acted irrationally in making the Cancellation Decision.

The Court rejected this submission. In the first instance, the Claimants argued that the LME should have instead allowed the trades to stand and calculated the margin requirements by reference to the 7 March 2022 closing price. However, the Court disagreed and accepted the Defendants’ position that calculating the margin requirements in this manner would have been “unacceptably risky”.

The Court also rejected the Claimants’ contention that the Defendants acted irrationally by failing to take other alternative options available to them, such as only cancelling some trades. Ultimately, the Court held that the LME was right to take a conservative approach and cancel trading for the entirety of 8 March 2022.

No obligation to consult the Committees

The Claimants argued that the LME's Special Committee and/or the Board Risk Committee were not consulted about the Cancellation Decision.

The Court found that there was no obligation to consult the LME’s Special Committee. Rule 22 of the LME rules conferred the power to cancel trades on the LME itself.

In relation to consulting the LME’s Board Risk Committee, the Court noted that the Board’s terms of reference did not require the LME to consult it and in any case, given the urgent situation on the morning of 8 March 2022, it would not have been possible for a meeting to have been convened.

Key takeaways

This judgment recognises the LME's obligation to maintain orderly markets and its powers to intervene to achieve this without a need to consult market participants. It also indicates that courts are willing to tailor their approach in judicial review cases to have regard to the contractual context, where one exists. In this case, the Court considered it significant that the Claimants agreed to the LME rules, and therefore, to the LME exercising its powers to suspend and cancel trading in certain circumstances. Further, the courts’ approach to judicial review will permit sensible latitude to decision-makers with specialist knowledge insofar as the decisions reviewed rested on, or were informed by, such knowledge. This judgment may influence how other exchanges respond to future ‘market emergencies.’

Traders on the LME and other UK exchanges may be concerned about the potential precedent this judgment establishes in terms of possible trade uncertainty, and how exchanges may react to crisis situations and other exceptional circumstances where – under MiFID II - exchanges are required to have the power to cancel or vary transactions (even if such situations are exceptional and occur rarely). The powers of exchanges and other public authorities can be broad and involve an interaction between private and public law. This case demonstrates that successfully challenging the decisions of such bodies may be difficult. Market participants who are unsure about the rights and powers of the exchanges in which they operate would be prudent to seek legal advice so that they can trade with greater certainty.

The decision is being appealed to the Court of Appeal.