The Financial Conduct Authority (FCA) has imposed a £9.2 million fine on the London Metal Exchange (LME) due to inadequate systems and controls during a period of intense market volatility. This case marks the first enforcement action against a UK recognised investment exchange, highlighting significant regulatory expectations for exchanges operating within the UK market. Between 4 and 8 March 2022, the price of LME’s 3-month nickel futures experienced extreme volatility, more than doubling within a short period and briefly exceeding $100,000. This event not only disrupted market order but also raised concerns regarding investor confidence and systemic risk.

Incident Overview

The events of early March 2022 were remarkable for their rapid escalation. Following significant price fluctuations, the LME suspended its nickel market for eight days, rendering all trades made on 8 March void. Amidst these tumultuous conditions, the FCA has stated that the LME’s internal controls failed to function as intended. Critical policies governing the operation of automatic volatility controls—specifically the ‘price bands’—were lacking. As a result, decisions designed to ensure orderly market operations rested with designated senior managers who were not adequately informed about the developing threats. According to the FCA, this gap in process allowed junior trading operations staff to make decisions without proper oversight during the most critical hours of trading.

Adequacy of Controls

The FCA’s assessment revealed that the LME’s controls did not ensure orderly trading in conditions of severe market stress. Key issues included:

  • Lack of Training: Only junior staff were present during the critical trading hours, which limited the ability to recognise market anomalies beyond simple error trades.
  • Inadequate Escalation Procedures: The processes for alerting senior management to potentially hazardous market conditions were insufficient, leading to delayed responses to extreme price movements.
  • Disabling of Price Bands: In an attempt to accommodate soaring prices, trading operations staff disabled the price bands during the height of volatility, increasing exposure to risk.

These failures allowed the nickel futures price to rise more sharply than necessary, significantly increasing market risks to participants.

Regulatory Response

The FCA’s investigation, initiated on 3 March 2023, was expedited, concluding more swiftly than typical inquiries, which often last around 42 months. The outcome underscores the regulator’s commitment to robust enforcement within the financial services sector. Steve Smart, the FCA’s joint executive director for enforcement and market oversight, stated, “London’s metal markets are of vital importance to the UK and global economy. We expect controls that match their significance.” This directive signals the FCA’s intention to hold exchanges accountable for their operational resilience, especially in volatile market conditions.

Improvements at the LME

In the aftermath of the incident, the LME has taken steps to rectify its shortcomings. The FCA acknowledged these efforts, demonstrating that the exchange is committed to enhancing and reinforcing its operational frameworks and customer protections. These improvements are not only vital for LME’s own reputation but also fundamental to restoring market integrity.

Broader Implications for Recognised Investment Exchanges

The LME case sets a precedent for other recognised investment exchanges regarding the importance of maintaining rigorous controls suitable for the scale and nature of their operations. Failures like those observed at LME can lead to severe penalties and loss of trust from investors and market users.
To avoid similar incidents, other exchanges should consider the following:

  • Regular Training: Ensure that all operational staff are well-trained to detect and respond to market anomalies, fostering a culture of risk awareness.
  • Robust Escalation Protocols: Develop clear procedures for escalating critical market events to senior management in real-time, ensuring timely decision-making.
  • Maintenance of Price Controls: Implement stringent governance around automatic price controls to mitigate risks associated with market volatility.
  • Continuous Review: Conduct regular assessments of systems and controls against regulatory standards and evolving market conditions.

Key Takeaways for Compliance Professionals

For compliance professionals, the LME case serves as a severe reminder of the regulatory environment’s expectations. It highlights the necessity of ensuring that adequate systems and controls are not just in place but are actively functioning during periods of extreme market stress. Compliance operations among recognised investment exchanges must:

  • Emphasise Governance: Ensure that governance frameworks are robust and can withstand scrutiny from regulators.
  • Prioritise Risk Management: Build a culture where risk management is prioritised across all levels of the organisation.
  • Engagement with Regulatory Developments: Stay abreast of regulatory changes, particularly regarding market stability and operational integrity.

Conclusion and Future Direction

The FCA’s penalty against the LME presents a significant case in the ongoing development of regulatory expectations. Recognised investment exchanges must heed this warning and enhance their compliance frameworks to avoid penalties and the reputational damage seen in this instance. Continued vigilance and proactive measures are essential to fortify market integrity.

How C&G Regulatory Solutions Can Help

C&G Regulatory Solutions offers expertise in navigating the FCA’s regulatory landscape. Our services can assist investment exchanges and investment firms in strengthening their compliance programmes and ensuring operational resilience against market pressures. If your firm requires support, contact us today to learn how we can assist you in aligning with regulatory expectations and enhancing your systems.

References

First FCA enforcement action and fine against a Recognised Investment Exchange