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Gold price reform to focus on improved transparency, governance controls

12th September 2014

By: Chantelle Kotze

  

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Instead of scrapping the century-old London Gold Fix altogether, gold industry role-players are calling for the modernisation of the method used to determine global gold price benchmarks, which is currently the subject of ‘intense’ debate, but not regarded as fundamentally broken.

This comes after increased scrutiny by European and US regulators of gold and silver fixes, along with other commodity benchmarks, regarding the processes and methods used to set commodity prices.

Incidents include the London Interbank Offered Rate, or Libor, case of widespread interest rate manipulation in 2012 and, more recently, Barclays, the group that controls South Africa’s Absa Bank, being fined £26-million by the UK’s Financial Conduct Authority in May for failures in internal controls that enabled a gold options trader to manipulate the setting of gold prices.

Industry players note that an optimal gold fix reform will require strengthening through transparency and governance improvements, among other improvement options.

Gold industry market development organisation the World Gold Council (WGC) central banks and public policy MD Natalie Dempster said in a statement – released in June after news of the Barclays fine – that it was no surprise that the London Gold Fix needs to change to meet current market expectations for enhanced regulation, transparency, liquidity, independent oversight and technology.

The WGC, which welcomes any efforts to increase transparency in the gold market, has subsequently identified five principles to which any reformed fix process, or alternative, should adhere to. Dempster noted that adherance to these principles would ensure a modernised gold benchmark “that meets the regulatory and customer landscape in which it operates”. These principles were drafted in addition to the principles for financial benchmarks stipulated by the Organisation of Securities Commission (Iosco), an umbrella group of market regulators.

“The WGC believes that the reformed gold fix should be based on executed trades and a tradable price. It should have highly transparent input data and be calculated from a deep and liquid market; it should also represent a physically deliverable price,” said Dempster in the statement.

These findings came from the WGC gold industry discussion forum, which was held in July to explore the proposed reform of the London Gold Fix.

Delegates from central banks, bullion banks, refiners and exchange-traded funds, as well as other gold investment product sponsors, exchanges and industry bodies attended the London-based event.

How the London Gold Fix Price Is Set
The Bank of Nova Scotia, HSBC, Société Générale and Barclays comprise London Gold Market Fixing.

Deutsche Bank, previously the fifth member of the fix, withdrew from the gold-fix panel in May after two decades.

The gold fix is set at 10:30 and 15:00 on each London business day during a conference call among the London Gold Market Fixing members, who work out a standard price based on transactions between their clients.

At the start of each conference call, the chairperson – selected from one of the banks – announces an opening price to the other members who relay the price to their clients. The clients will then declare themselves to be either buyers or sellers at that price.

Provided that there are buyers and sellers at the announced price, members are then asked to state the number of bars they wish to trade.

If a balance between buyers and sellers at the initially announced gold price is not met – within 50 bars of each other – the price is adjusted upwards and downwards until demand and supply are matched. The price is then declared fixed and all business is conducted on the basis of that price, until the next conference call.

Despite calls to alter the fix, bullion broker Sharps Pixley CEO Ross Norman believes that the existing London Gold Fix remains fit for purpose as “it does what is required in the fairest and most efficient manner”, barring a few minor modifications needed to assure adequate transparency and governance.

He explains that clients have the option to be notified of price changes during the fixing process, and that clients are aware of the level of interest or whether anyone has requested a pause – as the members assess their interests – while the settling is in progress.

Norman says clients are free to cancel, increase or decrease their interest on the basis of this information. He comments that few price setting processes offer clients this degree of flexibility.

Norman further states that the option to trade on the fixing price is open to all professional members of the bullion community, which gives the benchmark price validity, unlike the “here-and-now” spot price for gold, which operates at all other times and is subjective by nature.

He believes that official organisations use the London Gold Fix – rather than, for example, the spot price in many of their trades – because it is highly liquid, objective and has been well scrutinised and accepted as being the optimal way of trading.

Improving the Current London Gold Fix
To ensure that the current gold-fixing mechanism remains fit for purpose going forward, Norman says that, firstly, the way in which the process is governed needs to be changed and, secondly, wider transparency with regard to the fixing process beyond just interested parties and participants must be ensured for “quite literally, anyone who wants to observe the process in real time”.

“Currently, the London Gold Fix is overseen and operated by the same banks that participate in the fix and I think the governance and participation should be separate,” he says.
Norman explains that independent governance should effectively be undertaken by an external body that holds the participants to account while constructively overseeing the process, as opposed to being governed by the banks participating in the fix, as is currently the case.

In terms of transparency, making the fixing process universally available should not pose any problems, yet there is concern that some parties might want to monetise this information flow – which will unquestionably work against making it adequately visible, Norman adds.

He suggests that the banks participating in the fix should declare not only net interest of buying or selling orders, but also gross interest. They should also record the names of those parties involved at each level, as this would at least enable the regulator to effectively reconstruct a fix after the event if the regulator wanted to investigate trading by any of the parties involved.

Norman also stresses the importance of making the gold fix compliant with the Iosco principles.

Other Price-Benchmarking Options
Instead of determining the Gold Price Fix through a conference call, Norman suggests that it can be determined by recording the orders digitally, such as the new electronic price-setting mechanism used for silver price fixing.

Mining Weekly reported that the Chicago Mercantile Exchange Group (CME) and Thomson Reuters launched the new price mechanism, in association with the London Bullion Market Association (LBMA), last month.

The new LBMA Silver Price is a fully Iosco-compliant solution for the London bullion market and is expected to streamline the dissemination of data to numerous data vendors.

The LBMA Silver Price is auditable and determined through an electronic auction-based solution based on transactions. It is set in a series of auction rounds, with each round lasting 30 seconds. The auction begins at 12:00 and participants key in their buy volume and sell volume orders in lakhs (100 000 oz) or quarter-lakhs (25 000 oz).

The initial price at the start of the process will likely be close to the spot price. In the first round, the system algorithm will attempt to match buy and sell orders within the permitted tolerance level of three lakhs.

If the buy and sell orders are out of tolerance, the auction price will change and the auction will restart. The process continues until the buy and sell volumes are in tolerance and the equilibrium price is set.

“When considering the LBMA Silver Price, one struggles to identify any clear advantages or even advances over the old silver price fix,” says Norman, adding that it is no more transparent, efficient or flexible than the old silver price fix and does not do anything more to protect the process against possible malfeasance.

He says the only advantage might be in projecting the fixing commentary to a non- participating wider audience using the Internet for the sake of good order.

Similarly, the price fixing process has also not greatly changed in other areas, such as the traditional auction houses.

However, Norman says existing members of the London Gold Fix seem keen to be less involved in the process, as it is time consuming and earns them very little. The banks’ compliance departments are also cautious about any liability attached to being a part of the benchmark.

Meanwhile, the Singapore launch of the exchange-traded gold kilobar contract in June is a way of enabling the markets, particularly those in South-East Asia, to quickly become more efficient, to establish their own supply chains and to allow for gold to be traded in a modern, transparent manner while promoting new gold demand.

The gold kilobar contract will introduce centralised trading and the elimination of physically delivered gold, which is expected to provide a viable price benchmark in the region.

The London Gold Fix takes place after Asian markets close, whereas the Singapore kilobar gold contract will be transparently traded and cleared in Asian time on the Singapore Exchange, which will act as a central counterparty, prior to the opening of the London market.

Norman says that, while this is a positive step for gold price fixing, in that it enables a larger number of people to access the market through a product that suits their needs, the negative aspect is that a large institutional investor might be concerned that this fragmented market might not show adequate liquidity to easily accommodate its buying and selling order.

Going forward, Norman suspects a new system will be introduced when the London Gold Fix appoints a new administrator, which is expected to happen by year-end. However, it remains to be seen whether this will add anything to the current London Gold Fix system.

He says the London Gold Fix may well become the new LBMA Gold Price before the year is out, but the jury is out on whether or not the CME will win the gold contest to administer the gold benchmark, even though it has already “bagged” the silver.

Norman tells Mining Weekly that he expects the price fix for platinum and palladium to evolve similarly.

Edited by Creamer Media Reporter

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