Amid pressure from regulators, a new system for determining benchmark silver prices will be put in place from mid-August, while reforms are also under discussion in the gold market. Industry observers say increasing participation will be crucial to restoring confidence in the benchmarks, writes Gillian Carr The daily silver and gold fixings represent two of the oldest commodity benchmarks in the world, dating back to 1897 and 1919, respectively. But now, their long lives appear to be coming to an end. The silver fix is to be held for the last time in mid-August, while industry discussions were underway aimed at ‘modernising' the gold fix as Energy Risk went to press. In both cases, the developments will bring significant changes to the way benchmark prices are set for precious metals. With increasing concern about industry benchmarks and the potential for market manipulation, some industry observers believe reform is long overdue. "No benchmark is immune to fraud, but some are better than others, and these fixes are just about the worst I have seen. They enable co-ordination or collusion among players in a completely obscure way," says Rosa Abrantes-Metz, adjunct professor at New York University Stern School of Business and a specialist in anti-competition and manipulation cases. Both the gold and silver fixings rely on a panel of banks known as fixing members, but their numbers are dwindling. On April 29, Deutsche Bank announced it would resign its seats on both the silver and gold fixing panels. In the case of silver, Deutsche's exit would have brought the number of fixing members down to just two, making it impossible to continue the benchmark in its present form. Consequently, the company in charge of administering the fix – London Silver Market Fixing – announced it would cease to publish a daily price after August 14. Although the gold fix is not similarly threatened by Deutsche's departure, the London-based World Gold Council announced it would nonetheless convene an industry group to look at the modernisation of the gold fix on June 18 (see 'How the fixes work' box below). Regulator pressure At least in part, the reforms are being triggered by pressure from regulators. Financial benchmarks are facing increased scrutiny after a scandal over the rigging of Libor interest rates, which has cost banks billions of dollars in fines. In the wake of Libor, the closed-doors system for setting gold and silver prices has come under particular pressure. On May 23, the UK Financial Conduct Authority fined Barclays £26 million ($44 million) after it admitted one of its traders had manipulated gold prices in 2012. Due to continued worries about manipulation, Iosco released a set of principles for financial benchmarks in July last year. They call for additional oversight of governance – including the potential for conflicts of interest – and greater scrutiny of the design and integrity of benchmarks. The principles also lay out minimum standards in terms of methodology and accountability mechanisms, including complaints processes, documentation requirements and audit reviews. Elsewhere, the European Union is expected to push ahead with plans to regulate financial benchmarks, which will impose additional requirements on firms that publish or contribute to pricing mechanisms, after an initial proposal was published in August 2013. According to a Brussels-based spokeswoman for the European Commission (EC), a draft regulation is set to be discussed by the European Parliament's Economic and Monetary Affairs committee in September or October. The EC hopes the regulation will be adopted by early 2015. Market participants that spoke to Energy Risk agree there is plenty of room for improving benchmark pricing in precious metals. "The concept of the fix obviously needs to be updated," notes one London-based bank commodities head. "It needs to be electronic and you've got to do it based on market prices, which they do, but they don't have enough buyers and sellers in it currently. You need more buyers and sellers, without the barriers to entry that you have within the fixing members." The new benchmark for the silver market attempts to address concerns about the opacity of the silver fix, the breadth of participation in the process and the potential for market manipulation. The process will be run by Chicago-based CME Group and New York-based data vendor Thomson Reuters, after the two firms were selected from a variety of competitors by members of the London Bullion Market Association (LBMA), a trade group. Under the new arrangements, CME Group will operate the auction platform used to determine silver prices, while Thomson Reuters will provide independent oversight and distribute the data. The LBMA will own the benchmark and the two firms will run it for the association. The new process conforms to a demand from the LBMA that the new pricing mechanism be electronic, auction-based and auditable. Like the old system, the new process consists of a daily auction that goes through a number of rounds of bidding until the price is set, according to Thomson Reuters. As the distribution agent, Thomson Reuters will make anonymised bids and offers available to the market for each round of the auction, in addition to a daily price. The firms say the platform will provide more transparency, allowing a greater number of participants to see the process behind the formation of the benchmark. Meanwhile, the ability of an independent third party to audit the process will provide additional oversight, which a number of industry participants believed was missing in the old fix. Importantly, in addition to resolving some of the problems faced by the existing silver fix, spokespeople for both CME Group and Thomson Reuters say the new process will be fully compliant with the Iosco principles. Now a new benchmark process has been created for silver, there is speculation among participants that the gold market will adopt a similar approach. But the gold market won't necessarily replicate the same methods adopted by the LBMA, according to Natalie Dempster, London-based managing director for central banks and public policy at the World Gold Council. To date, the gold market's efforts to reform have been much more tentative. On July 7, a meeting held by the World Gold Council to discuss the modernisation of the fix was attended by 34 entities, including central banks, bullion banks, refiners, exchange-traded funds and other gold investment product sponsors, exchanges and industry bodies. While no firm decision was taken on an alternative process, a subsequent press statement laid out a series of requirements for any future benchmark. According to the statement, participants wanted a process that was based in London, physically settled, transparent and compliant with the Iosco principles. "We were looking to see how the gold fix stood against the principles," notes Dempster. Participation The reform of the two benchmarks is viewed as positive by industry observers concerned about market manipulation. In silver, the move to an electronic auction process should make the fixing more transparent and provide a proper audit trail, they note. But not all their concerns have been answered by the recent revamp. According to Stern's Abrantes-Metz, one of the biggest problems is that of participation. Shaun Ledgerwood, a Washington, DC-based principal at consultancy The Brattle Group, agrees. Having a variety of participants is extremely important for a benchmark process, he says, as it is one of the best ways to fight potential manipulation. Unless there is a robust level of participation from different players, he believes the market won't be liquid enough to stop individual trades skewing the index. "The fact is, if there is robust market participation, then even if I were to place a large trade into that market, the effect of that trade is going to be muted relative to if there were a relatively small number of trades," Ledgerwood says. The prospect of greater participation in the silver fixing is certainly welcomed by some physical silver market participants. "Instead of three banks getting on the phone and deciding every day, the process ideally will end up being more democratic," says Courtney Lynn, the Chicago-based treasurer of Coeur Mining, a US silver producer. Despite this, Lynn suggests it may be difficult to convince industrial firms and silver producers to participate in the fixings, as they have traditionally left benchmark pricing to financial players such as banks. "Ultimately, we're price takers and our resources are really best spent on what we do best, which is mining and not necessarily commodities trading, commodities risk management or silver or gold risk management." The new silver benchmark will allow for wider market participation, and there are plans to encourage more market players to participate in the fix, according to a Thomson Reuters spokesman. "The intention is that we get much broader participation. In the short term, the intention is to get all the market-makers involved. Then we aim to expand further in future to include other market participants," he says, adding the firm will work with the LBMA to make this happen. One senior London-based commodity trader says he would be pleased to see more non-banks participating in the price formation process, but thinks it will be difficult to put into practice. Such firms wouldn't know how much physical metal they would be required to trade in advance, so would need relatively flexible credit lines, he says. "In theory, it needs to be open to a wider group of people, however, it's a bit more complicated than you might think, because it means you need to have credit lines that are relatively open." Additionally, with the process relying on physical over-the-counter trading, any participating firm would need to have a vaulting relationship with one of the six designated clearing banks for London bullion gold and silver. That could further deter some potential participants, says the trader. Nonetheless, other industry observers are more sanguine about the prospects for increasing participation beyond major banks. "If you create it so you have transparency on the amount of volume on either side of the market, as you're moving towards the fix, I think there would be a tremendous interest in participating," says Jeffrey Christian, New York-based managing partner of CPM Group, a commodities research and consulting firm. "Banks are not the only people who can handle the credit." How the fixes work The way the gold and silver fixes operate has changed over time. Although each is slightly different, the basic process is essentially the same. Both processes involve a teleconference held between representatives of the fixing members. In the silver market, these are Deutsche Bank, HSBC and Scotiabank; in gold, the fixing members are Barclays, Deutsche Bank, HSBC, Scotiabank and Societe Generale Corporate and Investment Banking. For silver, one teleconference takes place at noon each day; for gold, two teleconferences occur daily at 10:30am and 3:00pm. Immediately before each fix opens, the chairman of the fix – chosen from participating banks on a rotating yearly basis – determines the prevailing US dollar spot price of physical metal held in London. At that price, fixing members are asked whether they have an interest in buying or selling. Fixing members are required to report their own interest in increments of 50,000 troy ounces for silver or 2,000 troy ounces for gold, but they are not required to report the interest of their clients.If there is no buying or no selling interest at the opening price, the chairman can announce the price as fixed. If there is buying or selling interest, the chairman will slowly edge the price up or down to reach a position where demand and supply are balanced – or failing that, where there is two-way interest at or below a maximum threshold of 300,000 troy ounces in silver or 20,000 troy ounces in gold. Once the benchmark is set, physical trades between fixing members take place in the over-the-counter market....
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