LONDON, June 19 (Reuters) - The London Metal Exchange will face two financial institutions in court on Tuesday over market chaos that resulted in billions of dollars of cancelled trades, in a case that could affect the reputation of Britain's capital as a financial centre.

The world's largest metals market enraged some investors in March last year when it annulled around $12 billion in nickel deals after prices erupted in a record-breaking surge, its first suspension of trading since 1988.

Britain's Financial Conduct Authority (FCA) in March launched an investigation into the trading halt, its first ever probe of a UK exchange for potential misconduct.

Hedge fund Elliott Associates and market maker Jane Street Global Trading are suing for a combined $472 million, alleging the 146-year old LME woefully failed in its responsibilities.

Elliott and Jane Street allege the LME failed to properly investigate chaotic nickel prices, whether the market was behaving rationally and what harm the decision to cancel trades would cause some market participants.

The LME has argued it had both the power and duty to close the market and cancel trades because $19.7 billion of margin calls would otherwise have led to the bankruptcy of multiple clearing members and created systemic market risk.

"The LME maintains that Elliott's and Jane Street's grounds for complaint have no merit and are based on a fundamental misunderstanding of the situation," the exchange said in a statement.

"All the actions taken on 8 March were lawful and made in the interest of the market as a whole."

The judicial review of the LME's decision brought by Elliott and Jane Street will take place over three days beginning on Tuesday. If the exchange were found to be at fault, a second trial would be held to decide on compensation.

Other lawsuits have been filed by other hedge funds, but since those revolve around the same issues, they have agreed to wait until a decision is made in the Elliott and Jane Street case before proceeding.

The impact of the case goes beyond the LME and will delve into when a financial exchange has the right to void trades that were legitimately placed, lawyers said.

"The cancelled trades are really embarrassing for London," said a lawyer specialising in regulatory issues, who declined to be identified. "This case could be really important for the City's reputation as a financial centre."

Reporting by Eric Onstad and Pratima Desai; Editing by Veronica Brown and Jan Harvey

Our Standards: The Thomson Reuters Trust Principles.

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