Exactly 19 months to the day after the International Board of the
Shanghai Gold Exchange (SGE) held its first full trading session on 19
September 2014, the Shanghai Gold Exchange launched the Shanghai Gold
Benchmark Price auction on 19 April 2016. In China, the number 19 is
very auspicious since it consists of lucky number 1, which means origin or
beginning, and lucky number 9 meaning everlasting, eternity, or longevity.
In another example of calculated Chinese planning, the SGE first
announced plans to launch its own gold fixing auction on 11 March 2015. This
was the week immediately prior to the launch of the LBMA Gold Price auction
on 20 March 2015, an event which occurred without any Chinese
banks being present in the initial participant list. This lack of Chinese
banks as initial participants in the LBMA Gold Price auctions was despite the
Chinese banks having made it clear in October 2014 that they wanted to be
present in the London auction on launch day:
“It’s been very welcome to see that quite a few banks in China are
very interested in taking part. They said they definitely wanted to be
there on day one for gold” [Ruth Crowell, LBMA CEO, October 2014
interview with MetalBulletin quoted here]
Two Chinese banks eventually joined the LBMA Gold Price auction, Bank of
China on 22 June 2015, and China Construction Bank on 30 October 2015, with
Industrial and Commercial Bank of China(ICBC) tee’d up to join the LBMA Gold
Price auction next month on 16 May 2016. However, sources in the gold market
have indicated that the Chinese banks, and others, had difficulty
establishing the necessary credit lines with the incumbent bullion banks that
are a LBMA perquisite for being a direct participant in the LBMA auction.
This need for bilateral credit lines between auction participants is not
something that the Shanghai Gold Benchmark Price suffers from, since it
is using a central clearing model, something that the LBMA have paid lip-service
to but that has never materialised (nor will it if the LBMA has its way).
The Shanghai Gold Benchmark Price – Details
The Shanghai Gold Benchmark Price, which I’ll abbreviate to SGE Gold Fix,
is a twice daily auction held on SGE business days at 10:15 am and 2:15
pm (Beijing Time). All time zones in China are officially the same time zone
(and run on Beijing Time), with Shanghai Time equivalent to Beijing Time.
The SGE Gold Fix auctions use the exchange code SHAU, and run on the
electronic SGE trading platform using a ‘centralised pricing trading’ auction
model. The auction is for physically-delivered 1 kg lots of 99.99% purity
gold or higher, quoted in RMB per gram, with a tick size of RMB 0.01.
Delivery is in the form of 1kg standard gold ingots of fineness 999.9 or
higher at SGE certified vaults. For the SGE Gold Fix, standard gold is
either gold from an SGE approved refinery, or gold from a LBMA approved
refinery. Settlement / Delivery is two days after trade date i.e. T + 2.
At this juncture it is important to emphasise that the Shanghai Gold
Benchmark Price is a centrally cleared auction on the largest physical
gold exchange in the world, that delivers real physical gold bars at any of
the SGE’s 55 certified vaults. Shanghai Gold Exchange uses 55 certified
vaults across 36 Chinese cities for gold storage. Unlike the LBMA Gold Price
auction which just settles and clears its trades as unallocated gold that
merely exists as a book-keeping entry in the database tables of the LPMCL’s
AURUM system.
The objective of the SGE Gold Fix auction is to arrive at a ‘Benchmark
Price’, which is a price at which supply and demand reach a balance,
while allowing a certain imbalance (less than 400 kgs) to remain. The
overall auction concept is therefore similar to the LBMA Gold Price auctions
in London. However, there are many features unique to the Shanghai
auction. The SGE Gold Fix involves a ‘Reference Price’ which is used as
the auction’s initial opening price. This reference price is derived from
prices entered into the trading system by two specific groups of auction
members during a 5 minute pre-auction window period called the ‘Reference
Price Submission Window’ which runs from 10:09 am – 10:14 am for the morning
auction and from 2:09 pm – 2:14 pm for the afternoon auction.
These two sets of members are ‘Fixing Members’ and ‘Reference Price
Members’. All of the Fixing members are financial institutions. The Reference
Price members include gold mining companies and gold jewellery
companies. The logic of obtaining opening reference prices from both
fixing members and reference price members is that the SGE feels it will
minimise price manipulation and price collusion since the reference prices
submitted include a broader set of entities (i.e. include non-financial
entities). This is a clever ‘checks and balances’ approach that is lacking in
the LBMA Gold Price auction.
The Members
At launch, there are 12 Fixing Members and 6 Reference Price Members. The
12 Fixing Members are all banks, 10 of which are pure Chinese banks. These
10 Chinese banks are the Big 4 state-controlled banks in the Chinese
Gold Market, namely Bank of China, China Construction Bank, Industrial
and Commercial Bank of China (ICBC) and Agricultural Bank of China, followed
by Bank of Communications, and also Industrial Bank, Ping An Bank, Bank
of Shanghai, Shanghai Pudong Development Bank, and China Minsheng Bank.
The final Fixing members are local entities of 2 foreign banks, namely Standard
Chartered Bank (China) and Australia and New Zealand Bank (China) (ANZ). Both
Standard Chartered and ANZ hold gold import licenses into China, as does
HSBC, however, there is no indication as of yet of HSBC becoming a Fixing
Member. This is despite a
report in January that China would penalise in some way a foreign bank
with a gold import license if it did not join the SGE Gold Fix. Two of
the 12 domestic bank holding gold import licenses, Everbright and China
Merchants Bank, are also absent from the SGE Gold Fix member list. Perhaps in
time, they, along with HSBC will sign up.
The 6 Reference Price members are Chow Tai Fook,
one of Hong Kong’s largest jewellery companies and which also has a huge
Chinese retail presence, China National Gold Group
Corporation (China Gold), the largest of the Chinese gold mining
companies, Shangdong Gold Group, another
large Chinese gold miner, Shanghai Lao Feng Xiang,
a large and well-known Chinese jewellery company, Bank of China (Hong Kong) Ltd, the RMB
clearing bank in Hong Kong, and the SGE’s appointed settlement bank for the
CGSE-SGE Gold Connect betwen the SGE and CGSE in the Hong
Kong Gold Market, and MKS (Switzerland),
the Swiss gold trading group that owns the PAMP
gold refinery and also owns New York based MTB.
The above is just an initial list of participants that have joined so far.
The SGE maintains that any qualified entity can join up in either the Fixing
of Reference Price member categories. SGE stipulates that Fixing Member
applicants are required to be financially-viable financial institutions that
are either active on the SGE or active in the global gold market, while
Reference Price applicants can meet one of a number of criteria such as “be
a leading producer or consumer in the gold industry” or “be involved
in the production, processing, trading, or investment of physical gold“.
The Auction Mechanism
The Fixing members and Reference Price members submit initial
reference prices. As to whether all members must submit a reference price is
a moot point. Article 12.2 and 12.3 of the Rules
for the Shanghai Gold Benchmark Price Trading state that the
Fixing and Reference Price members “must provide market reference price
at the designated time before the start of centralized pricing-trading“,
however, the Shanghai
Gold Benchmark Price White Paper (April 2016) describes a hierarchy
of contingencies in deriving the reference price, two of which cover
situations where less than 50% of members make a reference price submission.
The White Paper calculation methodology (algorithm) is as follows:
If > 50% of members submit a reference price, SGE calculates an
arithmetic mean after disregarding the highest and lowest submitted price.
If < 50% of members submit a reference price, the SGE
calculates an average (arithmetic mean) of all trades in the Au9999 spot
gold contract that have been executed on the SGE during the timeframe for
submitting reference prices.
If no trades were executed in the AU9999 during that time, the SGE
takes the Shanghai Gold Reference Price from the previous trading session as
the initial price. [this would be the previous afternoon benchmark
price if applied to the morning pre-auction etc]
The Au9999 is the SGE busiest spot gold contract. Based on
this three-pronged approach, it would seem that the members are not all
obliged to submit a reference price, otherwise the 50% threshold would never
arise unless due to communication outages or similar. The only logical
interpretation of the two documents is that if a member turns up to the
auction (or logs in to the trading platform), then they are obliged to submit
a reference price. If they don’t turn up, then there is no
obligation. Notwithstanding this grey area, after the reference price is
calculated the SGE then publishes the opening price.
Some readers will recall that ICE Benchmark Administration (IBA) uses a
‘human’ chairperson to come up with the opening price in the LBMA Gold Price
auction using a number of price sources that ICE Benchmark
Administration will not divulge. Nor will ICE Benchmark Administration
divulge the identities of the panel of chairpersons that it employs to chair
the daily LBMA Gold Price auctions. Frankly, this is a disgrace and a
scandal, and shows that the Chinese auction methodology is far more
transparent that its London counterpart. My hunch is that there are names
involved as chairpersons in the current LBMA Gold Price auction that were
also involved in the former London Gold Market Fixing Limited company which
operated the London Gold Fixing auctions. Otherwise, why keep the identities
a secret. No mainstream financial journalists in London will touch this
particular story, although they are all aware of it. See BullionStar
blog “Six
months on ICE – The LBMA Gold Price” for further details about the lack
of transparency in the administration of the LBMA Gold Price auction.
Once the opening price of the Shanghai Gold Benchmark Price is established
using the calculated reference price, the auction begins, and participants
and their clients submit their buy or sell orders and transaction volumes
etc. The auction consists of a first round and possible subsequent
rounds if supply and demand don’t reach a balance. There are two distinct
time periods in each round, a ‘market tendering‘ session and a ‘supplementary
tendering‘ session. The market tendering part is just the normal
part of the round where all participants and their clients submit
orders. The supplementary tendering session in each round only
applies to the Fixing members, and allows them to submit supplementary orders
against the remaining imbalanced quantity so as to try to reduce the
imbalance to less than 400 kgs and so speed up the auction, because if the
imbalance is shrunk to under 400 kgs, there is no need for an additional
round(s).
The first round consists of a 1 minute market tendering
session + a supplementary tendering session of 10 seconds. If the price
is not balanced after the first round, the SGE trading system will adjust the
price upwards or downwards depending on buy and sell orders, and then a
new round begins. Any and all subsequent rounds consist of 30 seconds
duration of a market tendering session + 10 seconds of a supplementary
tendering session.
Once the imbalance is less than 400 kgs, it is shared out among the Fixing
members. The price is then said to be balanced and the SGE then
publishes the benchmark price. The ‘Shanghai Gold Benchmark Price’ now has
its own web page on the SGE website here, with daily price
lookup, daily, monthly and annual charting (which will make sense when the
auction has been running for a while), and Trading Rules, Contract Spec
and Q & A (to be uploaded, but some of which are already detailed in the
Rules and White Paper linked above).
SGE Surveillance Committee
The SGE has also created an Oversight Committee to monitor and
oversee the auction’s functioning. This Committee currently comprises 11
representatives from 9 organisations. Although the names of the
representatives have not yet been published, the names of their organisations
have. The SGE will have 3 representatives, and the 8 other entities will each
have 1 representative. The list is as follows
- SGE 3
- ICBC 1
- Bank of China 1
- Standard Chartered Bank (China) 1
- ANZ Bank (China) 1
- China Gold Coin Corporation 1
- Baird Mint 1
- China Gold Association 1
- World Gold Council 1
Of the list of 11, seven reps come from pure Chinese entities, with the
remaining four from two foreign banks, the World Gold Council and ‘Baird
Mint’. All represented entities have connections with the SGE except it seems
Baird.
The Oversight Committee’s remit is to monitor trading, clearing, delivery,
in terms with SGE rules, analyse trading behaviour, examine conflicts of
interest etc.
Central Clearing
The SGE uses central clearing of the trades executed in the SGE Gold Fix
auctions and so there is no credit risk between participants. Under
central clearing, the exchange becomes the counterparty to all buyers and
sellers. This also avoids the need for participants to maintain bilateral
credit arrangements with each other, and so easily allows the number of
auction participants to grow, even exponentially. The lack of central
clearing in the LBMA Gold Price auction is a huge barrier to entry for
non-bullion bank participants and has been kept as such by the LBMA, even
though ICE offers central clearing and has been well able to implement a
centrally cleared model from Day 1 in March 2015. See ICE
Executive Summary which summaries the winning ICE bid for the LBMA
Gold Price wherein ICE discusses “moving to a centrally cleared model“.
The Purpose of the Shanghai Gold Benchmark Price
The Shanghai Gold Benchmark Price is but one more step in the growth
and deregulation of the Chinese gold industry, and the internationalisation
and extended use of the RMB. Much of this scene was set back in
2000 at the China
Gold Economic Forum. It’s also a natural step for a country that is the
largest gold producer, gold consumer and gold importer on earth. The SGE
Gold Fix also provides China with a real role in global gold price discovery
and creates the first proper transparent RMB denominated gold price
benchmark, calculated within a centralised trading auction setting on an
exchange.
An RMB gold price benchmark aids risk management and hedging in the
domestic gold sector, and can also now be used within Chinese
gold-backed derivative products, a function which the SGE has explicitly
mentioned. So expect financial products to appear that use the Shanghai
Gold Benchmark Price as a reference or valuation price. In China, where
gold is correctly recognised as the ultimate money, there is also the
prestige of having an internationally known global gold price benchmark, that
will, in SGE’s words “enhance China’s voice in the global gold pricing
market”.
In its White Paper, the SGE states that “the relationship between
Shanghai Gold and Loco London Gold is non-competitive”, and it lists a
number of reasons why this, on paper, is so, such as the London auction is
for the OTC trading of 400 oz bars of 99.5 purity quoted in USD, while the
Shanghai auction is Exchange-based trading for 1 kg bars of 99.99 purity
quoted in RMB. While this is true, these are only ‘contract spec’
differences, and having a PBoC controlled gold benchmark that is not in
London and not under the control of LPMCL clearing banks and the Bank of
England is a much bigger change than purely differing contract specs.
The Chinese play a long patient game and more often than not just go ahead
and do things / make things instead of just talking about doing things. The
SGE and the PBoC have now set up another part of the infrastructure that can
in time play a critical role in the global gold market as the Renminbi begins
to internationalise. Whenever the Chinese Government and PBoC move to allow
gold to be officially exported, this will really boost the new kid on
the block benchmark.
I would not think that the Chinese will want to make waves with this
Shanghai benchmark in the near future that would explicitly jeopardise their
relationships with the London Gold Market. The fact that the luminaries of
the global gold world were at the SGE Gold Fix launch
ceremony and the China
Gold Market Summit Forum on 19 April, much like they were at the launch
of the SGE International Board in September 2014, attests to the fact
that large players such as the World Gold Council, LBMA, MKS, ANZ and
Standard Chartered are very much in a cooperative relationship with the SGE,
the China Gold Association and the large Chinese banks. As the Chinese
Gold Market continues to evolve, my view is that the Shanghai
Gold Price Benchmark will naturally move into the ascendancy, and that its
physical gold price discovery influence will subtly begin to show up the
London Gold Market’s trading weaknesses (i.e. small % of physical traded), or
alternatively, the Chinese will at some stage call time-out when ready,
and allow the Shanghai Gold Price Benchmark to really shift up a gear to
generate physical gold prices that will disconnect from the COMEX and LBMA
pass the parcel shenanigans.
Ronan Manly
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