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LME precious combines flexibility of OTC with the liquidity of exchange trading

David Mears, VP – Precious Metals, London Metal Exchange



LMEprecious launched in July-2017 with the objective of complementing and reinforcing the existing London precious metals market. It was designed to provide a liquid and transparent venue for precious metals futures trading and clearing, and to settle efficiently into the existing loco London settlement infrastructure.

LMEprecious was developed with a group of leading industry participants who were committed to providing a London based centre of liquidity to reinvigorate the market, remove barriers to trading based on counterparty credit lines, and establish transparency across the forward price curve. 


Combining the flexibility of OTC with the liquidity of exchange trading

LMEprecious combines the flexibility of daily tradable dates for the first 25 days– which is an important feature for the physical market – with standard monthly futures going out to 5 years forward. This creates a flexible trading solution that complements the OTC market. Both the gold and silver contracts can be traded on a daily basis from T+1 (TOM), T+2 (Spot), through to T+25, and then monthly out to five years.

There is deep liquidity on the central limit order book provided by a diverse range of market participants. Trades can also be bilaterally negotiated and entered into the LME’s matching system, LMEsmart. This delivers greater user choice for market participants, helping to modernise the gold and silver markets to better reflect the needs of global players in precious metals markets.

LMEprecious is physically fungible with the OTC market, and designed to complement it,  as the gold and silver contracts settle into London’s existing settlement infrastructure. Gold and silver bullion are physically held in London vaults, allowing for efficient settlement between LMEprecious and OTC market deliveries.

Another key feature is the implied pricing functionality which combines outright spot liquidity with calendar spreads (carries) to create outright liquidity in monthly outrights with no legging risk.

Key benefits  of LME precious

For many new users, being able to access this liquidity without the need for bilateral relationships and credit lines with each counterpart is abig benefit and facilitates more business in the precious metals markets.

From day one there has been liquid carry pricing in depth out to 5 years, which has provided a transparent real-time forward curve based on real trading activity. Feedback from a range of precious market participants across the value chain has been very positive; this includes producers, refiners, banks and financial institutions.

For clients accessing LMEprecious they are effectively getting access to wholesale interbank liquidity and pricing. In some cases due to the capital benefits of clearing, liquidity providers may be able to offer better pricing on an exchange traded and centrally cleared platform.

LMEprecious already has eleven clearing members and a further three non-clearing members. The strong start demonstrates the appetite from the industry to trade precious metals on-exchange and to centrally clear. It is also an indication of the commitment from the industry to the LMEprecious initiative.

In August 2017 the LME began creating daily reference prices for gold and silver, these are volume weighted average prices (VWAPs) to support the precious metals market in managing their price risk throughout the trading day, and are aligned with periods of peak liquidity.


Capital efficiencies of central clearing

Regulators have taken a raft of steps to incentivise the industry to undertake more trading on-exchange and to centrally clear because of the security and resilience it can offer to financial markets. Resultantly, costs for trading OTC have increased. Banks involved in tradingprecious metals OTC are more likely to hold long-dated positions. These are more costly to hold on their balance sheets because of these increasing regulations, particularly regarding capital charges. The costs relate the capital that in required to be held against assets on the balance sheet.

For certain participants, an exchange-traded solution for gold and silver trading and managing exposure to precious metals provides significantefficiencies. This is a combination of capital benefits, operational efficiencies and the netting benefit of clearing positions compared to having to post initial margin multiple times in the OTC market. There is also a 60% margin offset between LME Gold and LME Silver positions.

These capital efficiencies are enabling more participants to access the market and carry outmore bullion business. The value of an exchange-traded and centrally cleared solution in London is evident from the significant growth in long-dated open interest on the LMEprecious contracts.


Opportunities for the Asian market as LMEprecious volumes grow

Loco London gold remains an integral part of global physical bullion trading. Most loco swaps are priced relative to loco London (loco London +/- USD per ounce) and many end users utilise loco London accounts to manage their bullion trading and hedging.

LMEprecious provides an additional deep source of liquidity to hedge outright loco London risk. On-screen spot liquidity is impressive with at least 100 lots of spot gold both sides and top of book consistently 20c wide. 

The benefits of trading on-exchange and clearing centrally, as outlined earlier, translate into deep liquidity on-screen right out to 5 years forward. This creates a vital source of liquidity for market participants looking at curve dynamics and opportunities further out, indeed we have seen trades executed on-screen out to 3.5 years forward.

Another key benefit for the Asian market is the increased transparency that LMEprecious provides. Live data for LMEprecious is available free of charge via LMElive, the LME’s own data application. LMElive offers 5 levels of real-time depth for spot gold and silver and live pricing out to 5 years forwards. End users can access this live pricing data on their mobile devices offering unparalleled transparency for loco London precious metals.This is hugely valuable to market participants whether they are traders, producers or consumers looking to hedge, roll positions and manage risks. 

The increasing internationalisation of the gold market also provides trading opportunities for market participants looking to manage basis risks or take a view on regional supply and demand dynamics. To this end LMEprecious provides a transparent, liquid, on-screen solution to trade in combination with other exchanges across the globe. Some brokers are already offering margin offset for gold traded on other major exchanges.

Disclaimer: Views are personal and not the views of the publisher.