August 11, 2016 / 1:06 AM / 3 years ago

Will LME consolidate or fragment London's bullion market?

LONDON (Reuters) - The London Metal Exchange (LME) has announced the launch next year of a suite of precious metals contracts, starting with gold and silver and eventually encompassing platinum and palladium.

Gold bullion is displayed at Hatton Garden Metals precious metal dealers in London, Britain July 21, 2015. REUTERS/Neil Hall

It’s not the first time the LME has ventured into the opaque world of London’s bullion trade.

Back in 1980 Robert Guy, director of N.M. Rothschild, one of the five bullion houses that dominated the city’s gold trading, announced the formation of a joint venture with the LME to trade gold.

“We know that the London Metal Exchange (...) will have a very positive contribution to make” to what would become the London Gold Futures Market, he said. (“Gold - A World Survey”, Rae Weston).

Alas, those great expectations came to nothing. The venture was laid to rest five years later due to a lack of liquidity.

Two attempts at silver trading, one in the 1980s and one in the 1990s, fared no better.

So will it be second, or in the case of silver, third time lucky for an exchange which still dominates the global base metals trading space?

Much has changed in the intervening years and the LME’s unique modus operandi looks a good fit for a bullion market being reshaped by regulation.

But much hasn’t.

The London bullion market remains a fractured and fractious community and there is a risk that the LME’s entry will cause further fragmentation rather than much-needed consolidation.

THE REGULATORY IMPERATIVE

The LME would bring “greater transparency” and a “higher degree of oversight” to the over-the-counter bullion market, David King, then chief executive of the exchange, told the Wall Street Journal in announcing the second doomed attempt to launch silver futures in 1998.

His words echo down the years.

“The initiative has been driven by the need for greater market transparency,” according to the LME’s announcement of its latest venture.

But allowing a little transparency into a notoriously dark pool of physical trading has gone from interesting experiment to pressing necessity in the intervening period.

A harsher regulatory light is being shone on the bullion market after the age-old “fixes” were deemed unfit for modern purpose and reinvented as “benchmarks”.

Coming down the line from Brussels is the regulatory monster that is MiFID II, or the Markets in Financial Instruments Directive (new and expanded version), which may well herald a shift to compulsory clearing of over-the-counter trading such as defines London bullion trading at the moment.

The LME is pitching its tent to capitalize on these changes, leveraging its own “cutting-edge, real-time clearing house”, LME Clear.

It has several clear-cut advantages.

It already operates the London platinum and palladium “benchmarks”. It already offers a combination of electronic and voice trading likely to appeal to bullion traders.

And it has a long history of operating a gateway between the over-the-counter and exchange-traded worlds of metals trading.

ALL ABOARD?

LME officials have been keen to portray the proposed gold and silver contracts as complementary to, rather than as a threat to London’s existing bullion trade.

But some, it seems, are not convinced.

The new products have been jointly worked on with the gold producers group, the World Gold Council, and have the backing of such heavyweights as Goldman Sachs, ICBC Standard Bank, Morgan Stanley, Natixis, Societe Generale and proprietary trader OSTC.

But there are several equally big bullion hitters missing from that list.

Also misssing in action is the London Bullion Market Association (LBMA), which represents gold and silver traders operating in the London market.

Confusingly, it too has been working on launching its own trading platform with the outcome of a tender for clearing and technology services still pending.

There again, with 82 members and 67 associates, decision-making at the LBMA tends to be a slow business.

Given the LME is already offering what looks a tailor-made solution to the shifting regulatory landscape, a second LBMA-led venture might appear superfluous.

But this is a body, remember, that chose to split the “fixes” three ways rather than consolidate them under one house.

While the LME took the platinum and palladium, ICE took the gold and CME-Thomson Reuters the silver, an outcome that made little sense to anyone not accustomed to the contradictory, and at times simply bloody-minded, London bullion community.

While the LBMA takes its time, the LME can do no more than hope that others will join the short list of official backers.

“Additional market participants are openly invited to participate in supporting and sharing in the success of the new contracts.”

It remains to be seen whether “additional market participants” will take or bite the hand of would-be friendship.

A CHALLENGE FROM THE EAST

Whether they do or not will determine whether the LME’s re-entry into the world of precious metals trading consolidates or fragments further the London market.

It’s a key moment in the market’s long history.

There is an increasingly clear danger to London’s role in trading and setting global reference prices for gold and silver.

Trading volumes on the Shanghai Futures Exchange’s gold products has been surging this year, notching up a fresh daily record of 500 tonnes on the day of the British vote to leave the European Union, according to Thomson Reuters GFMS.

Activity on the Shanghai Gold Exchange, which is openly challenging London for global benchmark status, surged by 59 percent to 12,044 tonnes last year, according to GFMS’ 2015 Gold Survey.

Liquidity in London, meanwhile, is widely thought to have suffered from a combination of regulatory cost, the resulting withdrawal of some big-bank players and the general constriction in credit lines.

It’s difficult to quantify given the, er, conspicuous lack of transparency in a market widely estimated to notch up $5 trillion in over-the-counter trades every year.

Which of course is precisely what the LME and its partners are hoping to help fix.

Just as long as they can persuade enough others to join them.

“We would welcome the London Metal Exchange as partners in this venture,” said Robert Guy back in 1980.

That welcome, with hindsight, was decidedly lukewarm. Will this time be different?

(The opinions expressed here are those of the author, a columnist for Reuters.)

Editing by Louise Heavens

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