Today the London Metal Exchange (LME) and the World Gold Council (WGC)
jointly announced (here
and here)
the launch next year of standardised gold and silver spot and futures
contracts which will trade
on the LME’s electronic platform LMESelect,
will clear on the LME central clearing platform LME Clear, and that will be settled
‘loco London’. Together these new products will be known as ‘LMEprecious’
and will launch in the first half of 2017.
However, although these contracts are described by the LME as delivery
type ‘Physical’, settlement
of trades on these contracts merely consists of unallocated gold or silver
being transferred between LME Clear (LMEC) clearing accounts held at London
Precious Metals Clearing Limited (LPMCL) member banks (i.e. paper trading via
LPMCL’s AURUM clearing system).
For example, the contract
specs for the LME’s planned spot gold trading state that the LME’s
proposed settlement procedure is one of:
“Physical settlement two days following termination of trading. Seller
transfers unallocated gold to LMEC account at any LPMCL member bank, and
buyers receive unallocated gold from LMEC account at any LPMCL member bank”
The range of LME contracts for both gold and silver will consist of a
trade date + 1 contract (T+1), aptly named TOM, as well as daily futures from
T + 2 (equivalent to Spot settlement) out to and including all trade dates to
T + 25. Beyond the daily futures, the suite of contracts also includes
approximately 36 monthly futures contracts covering each month out to 2
calendar years, and then each March, June, September and December out to 60
calendar months. The LME / WGC press release also mentions plans for options
and calendar spread products based on these futures.
As well as trading electronically on LMESelect, these precious metals
futures will also be tradeable via telephone market (inter-office market).
Trading hours for the daily contract (TOM) will be 1am – 4pm London hours,
while trading hours for all other contracts will be 1am – 8pm London hours,
thereby also covering both Asian and US trading hours. Detailed contract
specs for these gold
and silver
contracts are viewable on the LME website. The trading lot size for the LME
gold contracts will be 100 ozs, which is significantly smaller than the
conventional lot size of 5000 -10,000 ozs for gold trading in the London
OTC market (and conventional OTC minimum of 1000 ozs of gold). The
planned lot size for the LME’s silver contracts is 5000 ozs, again below
the conventional lot size of 100,000 – 200,000 ozs for silver
trading in the London OTC market (and conventional OTC minimum of 50,000
ozs of silver).
These LME contracts are being pitched as a real alternative to the
incumbent over the counter system of gold and silver trading in London which
is overseen by the London Bullion Market Association, an association whose
most powerful members are the clearing and vaulting banks in London, namely
HSBC, JP Morgan, Scotia, and to a lessor extent UBS and Barclays, but
increasing ICBC Standard bank as well. But given that the LME’s clearing will
sit on top of the LPMCL clearing system and use unallocated transfers,
the chance of any real change to the incumbent London gold and silver market
is non-existent. Nor will the trading of these LME products give any
visibility into the amount of physical gold and silver that is held within
the London Market, nor the coverage ratio between ‘unallocated account’
positions and real underlying physical metals.
Five Supporting Banks
This new LME / WGC initiative is being supported by other 5 investment
banks and a trading entity called OSTC.
These bank backers comprise US banks Goldman Sachs and Morgan Stanley,
French banks Natixis and Société Générale, and Chinese controlled
bank ICBC Standard Bank. According to a Reuters
report about the launch, the World Gold Council had approached 30
firms about backing the launch, so with only 5 banks on board that’s a 16.6%
take-up ratio of parties that were approached, and 83.4% who were not
interested.
Earlier this year in January, Bloomberg said in a report
said that the five interested banks were “ICBC Standard Bank Plc,
Citigroup Inc., Morgan Stanley, Goldman Sachs Group Inc. and Societe Generale
SA“, so somewhere along the line Citigroup looks to have taken itself
off the list of interested parties, while Natixis came
on board. The World Gold Council’s discussions about a proposed gold
exchange and its discussions with ‘5 banks’ appear to have begun as early as
the 4th quarter of 2014 and were flagged up by the Financial Times on 02
April 2015, when the FT
stated that:
“The WGC has hired a number of consultants and spent the past six
months pitching a business case for banks to consider the alternative trading
infrastructure”
“The World Gold Council…and at least five banks are participating in
initial discussions”
Notably, this was around the time that LME found out it had not secured
the contracts to run either the LBMA Gold Price or LBMA Silver Price
auctions. Note, that all 5 of the LME supporting banks, i.e. Goldman,
ICBC Standard, Morgan Stanley, SocGen and Natixis, are members of the London
Bullion Market Association (LBMA), with Goldman, Morgan Stanley, ICBC
Standard and SocGen being LBMA market members, and Natixis being a full
member of the LBMA. Goldman, Morgan Stanley, ICBC Standard and SocGen are
also direct participants
in the LBMA Gold Price auction operated by ICE Benchmark Administration.
None of these 5 banks are direct participants in the LBMA Silver Price
auction. Notably, none of these banks except for ICBC Standard is a
member of the precious metals clearing group LPMCL. ICBC Standard Bank
also recently acquired a precious metals vault in London from Barclays and
also joined the LBMA’s Physical Committee (see BullionStar recent blog ‘Spotlight
on LPMCL: London precious MEtals Clearing Limited‘ for details).
Therefore, ICBC Standard seems to have a foot in both camps.
Unallocated Balances, Unsecured Creditors
Given the long build-up to this LME / World Gold Council announcement, and
the fact that these LME spot and futures products were supposed to be a
genuine alternative to the LBMA bank controlled OTC trading system, the
continued use of unallocated settlement and the use of LPMCL accounts by
these planned LME contracts underscores that the LME contract do not
represent any real change in the London Gold and Silver Markets.
As a reminder, the resulting positions following transfers of unallocated
gold and silver through the LME Clear accounts of LPMCL members essentially
means the following, in the words
of none other than the LBMA:
“Unallocated account basis. This is an account where the customer does
not own specific bars, but has a general entitlement to an
amount of metal. This is similar to the way that a bank account
operates”
Additional LBMA
definitions of unallocated transactions are as follows:
“settled by credits or debits to the account while the
balance represents the indebtedness between the two parties.”
“Credit balances on the account do not entitle the creditor to
specific bars of gold or silver or plates or ingots of platinum or palladium
but are backed by the general stock of the precious metal dealer with whom
the account is held: the client in this scenario is an
unsecured creditor.
Alternatively, a negative balance will represent the precious metal
indebtedness of the client to the dealer in the case where the client has a
precious metal overdraft facility.
Should the client wish to receive actual metal, this is done by
“allocating” specific bars, plates or ingots or equivalent precious metal
product, the metal content of which is then debited from the unallocated
account”.
LME bows to LPMCL
However, it should come as no surprise that these LME spot and futures
contracts haven’t taken a new departure away from the entrenched monopoly of
the London gold and silver clearing and vaulting systems, for the LME
specifically stated in quite a recent submission to the LBMA that it
will never rock the boat on LPMCL’s AURUM platform. When the LME presented to
the LBMA in October 2014 in a pitch to win the contract for the LBMA Gold
Price auction (which it didn’t secure), the
pitch said that a centrally cleared solution “would only be
introduced with market support and respecting LPMCL settlement“. [See
right-hand box in below slide]:
In the same pitch, the LME also stated that:
“LME Clear fully respects existing loco London delivery mechanism and
participants“
[See bottom line in below slide]:
Interestingly, following the announcement from the LME and the World Gold
Council, the LBMA provided a very short statement that was quoted in the
Financial Times, that said:
“The LBMA saw the announcement with interest and reconfirms it has no
direct or indirect involvement in this project”.
While that may be true, what the LBMA statement didn’t concede is that 5
of its member banks, 4 of which are LBMA market makers, do have a direct
involvement in the LME / World Gold Council project. Nor did the LBMA
statement acknowledge that settlement of the planned LME gold and silver
contracts will use the LPMCL infrastructure, nor that the LPMCL is now in
specific scope of the LBMA’s remit.
Recall that in October 2015, the LBMA announced
that:
“the London Precious Metals Clearing company took part not only [in
the LBMA] review, but we have now agreed to formalise our working
relationship, with the LBMA providing Executive services
going forward. I’m grateful to the LPMCL directors for their
leadership and their support for removing fragmentation
from the market.”
With the LME contracts planning to use LPMCL, this ‘new dawn’ view of the
LME / World Gold Council initiative is in my view mis-guided.
Even COMEX has more Transparency
Anyone familiar with the rudimentary vaulting and delivery procedures for
gold and silver deliverable under the COMEX 100 oz gold and 5000 oz silver
futures contracts will know that at least that system generates vault
facility reports that specify how much eligible gold or silver is being
stored in each of the designated New York vaults, the locations of the
vaults, and also how much of the eligible gold or silver in storage has
warehouse warrants against it (registered positions). The COMEX ‘system’ also
generates data on gold and silver deliveries against contracts traded.
However, nothing in the above planned LME contract specs published so far
gives any confidence that anyone will be the wiser as to how much gold or
silver is in the London vaults backing up the trading of these spot and
future contracts, how much gold or silver has been converted post-settlement
to allocated positions in the vaults, nor how much gold or silver has been
delivered as a consequence of trading in these spot and futures contract, nor
importantly, where the actual participating vaults are.
This is because the LMPCL system is totally opaque and there is absolutely
zero trade reporting by the LBMA or its member banks as to the volumes of
gold and silver trading in the London market, and the volumes of physical
metals held versus the volumes of ‘metal’ represented by unallocated account
positions. Furthermore, the LBMA’s stated goal of introducing trade reporting
looks as dead as a dodo, or at least as frozen as as a dodo on ice.
LBMA stall on Trade Reporting, LPMCL clear as Mud
On 9 October 2015, the LBMA announced that it had launched
a Request for Information (RFI) asking financial and technology providers
to submit help with formulating solutions to issues in the London bullion
market such as greater transparency, liquidity that had supposedly been
recommended as strategic objectives by consultant EY in its report to the
LBMA that incidentally has never been made publicly available. On 25 November
2015, the LBMA then announced
that it had received 17 submissions to its RFI from 20 entities spanning
“exchange groups, technology firms, brokers and data vendors”.
On 4 February 2016, the LBMA then issued a statement saying that it was
launching a Request for Proposals (rRfP) and inviting 5 of these service
providers (a short-list) to submit technical solutions that would address
requirements such as an LBMA data warehouse and that would support the
introduction of services such as trade reporting in the London bullion
market. The RfP statement said that the winning service provider would
be chosen in Q2 2016, with a planned implementation in H2 2016.
However, no progress was announced by the LBMA about the above RfP during
Q2 2016, nor since then. The only coverage of this lack of newsflow came from
the Bullion Desk in a 27 May article titled “Frustration
Grows over London Gold Market Reform” in which it stated that the 5
solution providers on the short-list were “the LME, CME Group, the
Intercontinental Exchange (ICE), Autilla/Cinnobar and Markit/ABS“, and
that:
“the pace at which the LMBA is moving forward are causes for
consternation in some quarters of the sector”
A quote within the article seems to sum up the sentiment about the LBMA’s
lack of progress in its project:
“It’s not going to happen any time soon. Look at how long it’s been
going on already,” another market participant said. “Don’t hold your breath.
It seems like we still have a long way to go.”
What could the hold up be?. Surely 17 submission from 20 entities that
were whittled down to a short-list of 5 very sophisticated groups should have
given the LBMA plenty of choice for nominating a winning entry. Whatever else
this lack of progress suggests, it demonstrates that an increase transparency
in London gold and silver market trading data is not going to happen anytime
soon, if ever.
Furthermore, the opacity of the London clearing statistics that are
generated out of the LPMCL clearing system need no introduction, and can be
read about here.
Conclusion
According to the LBMA, ‘Loco London’ “refers to gold and silver
bullion that is physically held in London“, however, given the secrecy
which surrounding trading data in the London gold and silver markets, and the
lack of publication by any bank of the proportion of unallocated client
balances in gold or silver that it maintains versus the physical gold or
silver holdings that it maintains, this ‘loco London‘ term appears
to have been abused beyond any reasonable definition, and now predominantly
refer to debit and credit entries in the virtual accounting systems of London
based bullion banks. Nor, in my opinion, will the LME contracts change any of
this. One would therefore be forgiven in thinking that the real underlying
inventories of gold and silver in the London market and their associated
inverted pyramid unallocated account positions are too ‘precious’ to divulge
to the market. the Bank of England is undoubtedly licking its chops to the
continued opacity of the market.
And its not just my opinion. This latest LME / World Gold Council /
investment bank announcement has generated other skeptical reactions. The
last word goes to Jim Rickards, who tweeted this in reaction to the latest
LME / World Gold Council news:
World is running out of physical gold, so #Goldman found a way
to create more paper gold: https://t.co/1AIHQjLV3X
pic.twitter.com/UPFnIae4Is
— Jim Rickards (@JamesGRickards) August 9,
2016
Ronan Manly
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