In Age of Market Scrutiny, Who Wants in on the Gold 'Fix'?

Wednesday, 22 Jan 2014 07:18 AM

 

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Deutsche Bank's decision to put its seat at the gold fixing table up for sale has raised questions about the future of the price benchmark.

One stands out: who, after the Libor scandal, will want it?

Gold price setting or "fixing," determining the benchmark for the billions of dollars traded every day, is nearly a century old. The modern twice-daily system launched in 1968.

Unlike most commodities which are dominated by futures trading, gold is chiefly a cash market.
Involvement in the fix offers little financial benefit to members, but a seat at the table is prestigious. However, that may not be enough.

"It's a tough sale at the moment," one source in the London precious metals market said.

"There's nothing really in it for the banks, except the opportunity to say that they're a fixing member, which carries certain kudos."

Increased scrutiny, with regulators pushing for new rules on commodity benchmarks after the Libor scandal, threatens to outweigh that benefit, the source said.

Regulators including Germany's Bafin, Britain's Financial Conduct Authority and the U.S. Commodity Futures Trading Commission have increased scrutiny of commodity indices after the London Interbank Offered Rate, Libor, was rigged by British banks.

The International Organization of Securities Commissions (IOSCO) issued guidance in July covering all benchmarks that are central cogs in the global economy, from interest rates to equities and gold.

A handful of banks getting together to decide the benchmark gold price twice each business day is seen by detractors as anachronistic and opaque.

"It is a very old-style, archaic system and it is amazing that such a way of doing business has survived the modern day and age, where everything is so fast and electronic," Saxo Bank senior manager Ole Hansen said.

Gold market participants say concerns about opacity reflect a fundamental misunderstanding of how fixing works.

"The fix, unlike Libor, is a key pricing mechanism that involves the whole of the interested parts of the market at any one time, from jewelers up to central banks participating in pricing through the fix," Rhona O'Connell, head of research at Thomson Reuters GFMS, said. "Any market participant can change his order at any time, and the market is fully transparent."

"It's not as if it's a majority vote on the price, after all, it's the whole of the interested market that's involved."

Apart from Deutsche, four other banks take part in the fixing - Barclays, HSBC, Societe Generale and ScotiaMocatta.

At the start of each fixing, the chairman announces an opening price to the other four members, who relay that to their customers and, based on orders received from them, instruct their representatives to declare themselves buyers or sellers at that price.

The gold price is adjusted up and down until demand and supply is matched, at which point the price is "fixed".

Sources said banks involved in the gold fix are reviewing the mechanics of its process to try to ensure that the benchmark complies with upcoming regulations.

"With all the scrutiny on benchmarks, starting with Libor, it makes sense to make sure that the way the fixing is conducted doesn't leave itself open to accusations of manipulation," one source said.

"They are asking the question, can we do more to make sure that this is as foolproof and watertight against allegations of being influenced as it can be?"

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Increased regulatory scrutiny looks like the stumbling block in finding a buyer for Deutsche's seat.

"There could be quite a few contenders but it also depends on what effect all the regulatory focus has," one gold market source said. "If regulators are going to say 'well the fix doesn't work as it is, and we have to find another way of doing it', nobody is going to want to buy that seat."

It is Deutsche's responsibility to find a buyer for the seat, who would have to meet with the approval of the other members. The price would be negotiated between the buyer and the seller. The last time a seat was sold in 2004, it cost around 1 million pounds ($1.6 million), sources said.

A logical possibility would be for another of the London Bullion Market Association's market-making members, who quote two-way prices to each other during the London business day for agreed minimum quantities, to take a place at the table.

The market makers not currently involved in fixing — Credit Suisse, Goldman Sachs, JPMorgan, Merrill Lynch, Mitsui Precious Metals and UBS — declined to comment on whether they would be interested.

A candidate is more likely to emerge among the Asian banks, sources say, as these look to raise their profile in the London market at a time when Asia is taking a more important role in the gold industry as physical metal moves eastward.

Chinese banks have increased their profile in the London gold market. Bank of China and Industrial and Commercial Bank of China (ICBC) are already members of the LBMA. ICBC is also about to complete the acquisition of the London commodity arm of Standard Bank, another member of the London Bullion Market Association.

Both banks declined to comment on whether they were interested in joining the fixing group.
If no buyer is found, it could potentially continue with just four members, but that is unlikely to happen. Without Deutsche, only two banks, ScotiaMocatta and HSBC, will be involved in silver fixing.

Gold traders say the benchmark still has value, helping them to hedge risk, which would be more difficult if they were negotiating sales privately with each client.

"There isn't really another way you can get a fair snapshot of the market twice a day," one gold trader said. "If the fixers step away, it leaves it open to questionable prices being put through, with no reference to where the actual gold price is."



© 2014 Thomson/Reuters. All rights reserved.

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