02nd Global Gold Dore Forum on 14-15 Jan 2018 at Hilton Dubai Jumeirah, Dubai, UAE. Concluded Successfully...
 You are here : Home > Expert Column
 
 

Loco London Exchange-traded Precious Metals

Alex Shaw explains why the London bullion market is looking to exchange trading and clearing of precious metals and the significance of these developments for the Asian market.

The changing face of global markets

Since the financial crisis, the direction of global financial regulation has been to encourage a migration of bilaterally traded products towards centrally cleared and exchange traded venues, in order to reduce systemic risk in financial markets and in support of promoting fair and transparent markets.

In 2017, the LME commissioned Deloitte LLP to summarise the regulation relating to cleared and non-cleared trading [1].  The LME’s observations on the relative impacts of the current and emerging regulatory landscape on cleared and non-cleared trading include:

·         Higher capital charges for non-cleared over-the-counter (OTC) derivatives

·         Increased cost of trading for non-cleared OTC trades

·         Leverage ratio implications

·         Netting benefits from central clearing

·         Operational benefits

·         Reduced OTC market liquidity

·         Increased transparency in the OTC market.

LMEprecious

In July 2017, in response to these changing market conditions and market demand for an exchange traded loco London precious metals venue, the LME worked with a group of leading industry participants to launch “LMEprecious”.  LMEprecious provides exchange trading and clearing for loco London spot, daily and monthly futures of 100oz. gold and 5,000 oz. silver contracts, with the goal of providing a London based centre of liquidity, reinvigorating the market, removing barriers to trading based on counterparty credit lines and providing a transparent forward curve.

For many banks in particular, exchange trading and clearing provides significant capital savings, operational efficiencies and streamlined trade reporting, making it more cost effective to service clients.

Trading LMEprecious contracts

The LMEprecious gold and silver contracts provide considerable flexibility of trading format and a one-stop solution for trading spot, outright futures, calendar spreads and, later this year, also options. 

Figure 1: Trading LMEprecious contracts as outrights and calendar spreads

Figure 1 above illustrates that there is a daily dateline of tradeable contracts out to 25 days forward and also a monthly set of dates that settle on the third Wednesday of each valid calendar month.  Each of these dates can be traded on an outright basis or as liquid on screen calendar spreads from spot to each forward date.  The focus of liquidity is on the spot contract and in the calendar spreads, with implied pricing connecting the top of book outright and the calendar spreads into outright monthly tradeable prices.  In addition, it is possible to trade calendar spreads between any valid prompt dates.

Indeed, a key feature of the LMEprecious contracts is the ability to roll a spot position on screen on a daily basis (which incurs exchange and clearing fees of only $0.02 per lot) and where daily roll bid/offer spreads on gold are frequently $0.001 wide.

Liquidity on the central limit order book

LMEprecious launched on 10 July 2017 and by the end of the year, the LME Gold contract had seen 1,989 tonnes of gold traded, making the LME the fourth-largest global gold futures exchange for that period.  LME Silver also saw strong volumes with 14,870 tonnes traded in 2017.

The growth of open interest (OI) has been an equally impressive story, with LME Gold and LME Silver at c. 30,000 lots and c. 5,000 lots (93t and 777t) respectively in the first four months of 2018.  The ability to trade liquid on-screen monthly contracts across the curve has seen considerable longer-dated OI develop, with approximately 80% of OI beyond the first monthly date and significant OI out as far as 3.5 years forward.

LMEprecious provides an additional deep source of liquidity to hedge outright loco London risk. On-screen spot liquidity is significant with at least 100 lots of spot both sides and top of book consistently 2 ticks wide (20c for gold and $0.10 for silver respectively).

Transparent price discovery

The LME provide free real-time access reference prices at key times during the London trading day (as shown below in Figure 2), based on on-screen streamed tradeable quotes and trades[2].  These prices have shown very high correlation to the prevailing loco London OTC market. 

Figure 2: Daily reference prices and closing prices

Later this year the LME will be implementing trade-at-settlement (TAS) functionality that will allow buyers and sellers to match and trade at (or at a number of ticks above or below) a yet to be defined LME settlement or reference price.  

From June 2018 there will be on-screen liquidity from 01:00 London time, creating the opportunity to provide reference prices during the Asian trading day, should the market require.

Forward curve

The LME has historically administered the official GOFO rates based on submitted data until they were decommissioned in 2014.  The availability of a daily forward curve helps users across the value chain inform investment decisions, value positions and more broadly understand price trends further down the curve.

LMEprecious provides free real time on-screen pricing out to five years and also a closing price curve each day based on trading activity on LMEselect.  The launch of LMEprecious on LMElive this summer will make this data even more convenient to access.

It is also possible to derive gold forward rates from LMEprecious data[3], as shown in Figure 3 below from 1 month out to 1 year. The same data is available out to 5 years forward going back to the first day LMEprecious launched on 10 July 2017.

Figure 3: LME Gold implied forward rates

The chart clearly illustrates the spike in gold rates seen at the end of 2017, considered to be down to a number of factors, such as end of year position keeping, low liquidity and the expectation of US rate hikes in 2018.

The direction and sentiment behind recent regulatory changes clearly points to a new era of transparency.  The LMEprecious forward curve provides an ideal solution for the market, as it is based on on-screen trade and order data on a regulated Recognised Investment Exchange (RIE) and made freely available to the market.

Relevance to the Asian market

For the Asian market, LMEprecious provides the ability to access real-time loco London spot order book data and a streaming forward curve out to five years via major market data vendors, and also freely available on desktop and mobile devices via LMElive[4] from Summer 2018. 

This is hugely valuable to market participants whether they are traders, producers or consumers looking to hedge, roll positions and manage risks.

In response to client demand from Asia, in June 2018, LME will launch a liquidity provider programme to expand on-screen pricing provision to the period from 01:00 to 08:00 London time.  Increasing liquidity during this crucial period crystallises many of the benefits described above for the Asian market; indeed most other exchanges see a significant share of trading during this time window.

The increasing internationalisation of the gold market also provides trading opportunities for market participants looking to manage basis risk 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 against gold positions traded on other major exchanges.

One stop solution for trading gold and silver

This year the LME is also developing options on the existing gold and silver monthly futures contracts out to two years forward.  This provides greater flexibility to manage risk and positions across both futures and options on the same platform, providing potentially significant portfolio efficiencies for margining across spot, futures and options positions, with a 60% initial margin offset between gold and silver positions.

Furthermore, the ability to access transparent and freely available reference prices that can be traded on a TAS basis creates a platform that can service all market needs, with increased liquidity during Asian trading hours and an increasingly active broker market that will be enhanced with a service for registered intermediating brokers (RIBs) to broker trades for clients and members on an anonymous basis later this year.

Alex Shaw is responsible for the development of the LMEprecious product suite and the LBMA Platinum and Palladium Price Discovery Process. Prior to joining the LME, he was a Strategy Consultant at Monitor Deloitte, where he led projects across financial services. Alex started his career with Accenture and Korn Ferry. He holds an MBA from INSEAD and an MA (hons) from the University of Cambridge.

David Mears is an Assistant Vice-President in the Precious Metals Market Development team at the London Metal Exchange. He previously worked as an Associate Director in Commodities Sales at Standard Chartered Bank covering global precious metals clients. He has a BA in Chinese and Economics from London School of Oriental and African Studies (SOAS).

 



[2] Further details and daily prices can be found on the LME website: https://www.lme.com/Metals/Precious-metals/LMEprecious-reference-prices

[3] Please email the LME at LMEprecious@lme.com for a formatted spreadsheet providing conversion to forward rates

[4] LMElive is the LME’s own market data platform.  More information is available on the LME website: https://www.lme.com/Market-Data/LMElive

 

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