LME's pitch for share of
gold market faces bumpy ride
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[January 23, 2017]
By Peter Hobson and Pratima Desai
(Reuters) - Fears of inflexibility and rising costs are sapping
enthusiasm for the London Metal Exchange's new suite of gold contracts,
potentially leaving the exchange reliant on the threat of an increasing
regulatory burden to drive uptake.
London's $5 trillion-a-year gold trade has, along with the rest of the
City of London, found itself under increased scrutiny since the Libor
scandal, with U.S. lawsuits alleging rigging against the banks that set
Regulatory pressure sparked the fall of the near century-old
telephone-based gold fix, or benchmark pricing, which was replaced by an
electronic alternative in 2015, and reform of the management structure
of the London Bullion Market Association.
The LME, owned by Hong Kong Exchanges and Clearing Ltd (HKEx) <0388.HK>,
says its contracts, which include spot, futures and options, would bring
price-setting out of the back rooms of banks by creating a published
forward pricing curve for gold and sliver out to five years.
It also says the contracts' central clearing would free the banks and
brokers that dominate London's over-the-counter (OTC) gold market from
increasingly onerous capital requirements, creating savings that could
be passed to others in the industry.
But a source at a major gold trading bank said: "There's a lot of
caution and probably outright scepticism from market participants
whether this will add anything but another cost to the bottom line."
"In the OTC market there are no fees, you call somebody for a quote and
you trade it," a source at a metals broker said.
The LME hasn't detailed the fees for trading and clearing using LME
Clear, but said it is "confident that fee levels will be competitive".
Scepticism runs deep, however. Metal industry sources cite other failed
attempts by the LME to establish new contracts including those for
cobalt, molybdenum, plastics and aluminum premiums.
"This set of contracts was never intended to replace or undermine the
OTC market." said Robin Martin, head of market infrastructure at the
World Gold Council, an industry body that worked with the LME to design
He said he expected most of the volume on the contracts to come from
hedging between banks and brokers - which he said accounts for up to 90
percent of trading in the London market.
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Gold granules at the Austrian Gold and Silver Separating Plant 'Oegussa'
in Vienna April 16, 2013. REUTERS/Heinz-Peter Bader/File Photo
could continue to agree trades bilaterally as under the OTC model, and then
clear them on the exchange, enabling savings that would reduce costs for all the
industry, he said.
LME brokers say the specifications are restrictive and the contracts, though
physically deliverable, appear to be designed for finance professionals and not
the physical market.
A key criticism is the size of the contracts: 100 troy ounces for gold and 5,000
ounces for silver. On the over-the-counter (OTC) market gold and silver can be
traded in any number of ounces.
"What happens if our customers want to trade 330 ounces of gold?" asked one gold
The monthly contract structure meanwhile undermines physical traders' ability to
hedge specific dates beyond a month, said a source at a metals broker.
said at least 30 firms had been consulted during the design process. The
contracts allow combinations of daily and monthly futures to hedge any date, he
said, while defined lot sizes allow easier netting, compensating for lost
Most gold producers contacted by Reuters said they would not use the LME
contracts to hedge, though one, Petropavlovsk, said it would consider doing so.
Five banks, Goldman Sachs, ICBC Standard Bank, Morgan Stanley, Natixis and
Societe Generale, and proprietary trader OSTC have partnered with the LME and
committed to supply liquidity.
But two of biggest gold trading banks, JPMorgan and HSBC, have not.
"We think we've got critical mass," said Martin.
Sources said the LME would struggle to gain a share of the market, particularly
given that Shanghai and New York already offer well-established and liquid gold
"Trading will always go to the place with the most liquidity," a source at a
major gold trading bank said.
(Additional reporting by Barbara Lewis; Editing by Veronica Brown and David
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