Tag Archives: Bank of China

Shanghai Gold Benchmark Price – New Kid on the Block

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).

SGE bar

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“.

SGE Benchmark

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 contractBased 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

  1. SGE  3
  2. ICBC  1
  3. Bank of China  1
  4. Standard Chartered Bank (China)  1
  5. ANZ Bank (China)  1
  6. China Gold Coin Corporation  1
  7. Baird Mint  1
  8. China Gold Association  1
  9. 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 summarises 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.

Chinese Banks as direct participants in the new LBMA Gold and Silver Price auctions? Not so fast!

There is a growing assumption in the financial media that a number of Chinese banks will be joining the new LBMA Gold Price auction as direct participants when the auction launches in London on Friday 20th March. This assumption is based on various sources, but primarily on a number of general comments made by the London Bullion Market Association (LBMA) in February, and also some comments made by the LBMA last October.

ICE Benchmark Administration (IBA), the administrator for the LBMA Gold Price, issued a press release on 2nd February in which the Chief Executive of the LBMA, Ruth Crowell said:

“I’m delighted to see a high level of interested participants for the March launch. The intention and the interest has been very positive and creates a more diverse pool of participants which includes Chinese banks. We look forward to having enhanced numbers of participants for day one for the LBMA Gold Price.”

ringin the bell

There are, however, a number of dangers in assuming that some of the Chinese banks will be direct participants in the new gold auction at launch date, not least of which is that the identities of the direct participants will only be revealed on 20th March, but also the fact that the LBMA’s comments above didn’t specifically say that Chinese banks will be direct participants on launch date. The LBMA’s comments merely said that Chinese banks were interested in participating in the auction.

ICE Benchmark has just published an FAQ document on its website, and in answer to “Who are the direct participants in the auction?”, it states “direct participants will be announced on the day of launch.” Note that the LBMA refers to the entities that will participate at launch date as ‘phase one participants’.

Indeed, the vague nature of the reference to Chinese banks in the 2nd February press release forced the major financial media outlets to be non-committal about the Chinese banks as direct participants on launch date.

For example, on 2nd February 2015, Bloomberg published an article titled “Chinese Banks in Talks to Take Part in Gold Fix Replacement”, in which it stated that:

‘There’s a “more diverse pool” of participants, including from China, interested in being part of the LBMA Gold Price, Ruth Crowell, chief executive of the London Bullion Market Association, said in a statement Monday. The LBMA declined to comment on the number and names of those in talks for the new mechanism that will start in March.’

The Financial Times was slightly more definitive with its guesstimate in an article, also published on 2nd February (subscription), titled “Chinese banks to join new gold fix from March”, in which it said:

“The replacement for the near-century-old London gold fix will start in March, with the hope of attracting at least 11 members, including Chinese banks for the first time.”

“The presence of Chinese banks would give the world’s second-largest consumer of the precious metal a greater say in the global gold price.”

Direct Participants

There is also a danger in assuming that the LBMA’s use of the word ‘participant‘ refers to ‘direct participant in the auction‘, although it’s totally understandable that most people would make this assumption. As is often the case, the LBMA’s communications and press release language leaves a lot to be desired when addressing anything to do with the gold and silver fixings, and needs to be read and interpreted carefully. Furthermore, in my view, neither the LBMA nor ICE have publicised and explained the concept of direct participant properly.

Therefore, many commentators on the new Gold Price auction don’t seem to realise that there is a difference between being a direct participant in the auction and another type of participant in the auction. At the end of the day, this other type of ‘participant’ is basically just a client of a direct participant.

Although ICE says in its FAQ document that “the auction is designed to allow as broad participation as possible”, it does not elaborate.

Where it does elaborate is in the executive summary of its proposal that it used in October to secure the administration of the new Gold Price auction. Here, ICE states that one of the key advantages of its offering is:

“A fair and sustainable fee structure, designed to encourage direct participation from a diverse cross-section of market participants and broad use of the price as a benchmark.”

We have designed our commercial model to promote direct participation in the fixing process and broad usage of the benchmark. And, in designing the commercial model, we have considered the particular nature of the London Gold Fix and its usage in the financial markets.”

It goes on to say:

Traditional clients such as miners, refiners, jewelers and central banks can choose to become a direct participant and deal anonymously in the gold auction. Alternatively, if sponsored by a direct participant, they can be given their own screens and manage their own positions by trading through their sponsor.”

“One of the key benefits of WebICE is its ability to allow clients to participate in the auction process with the same information and order management capabilities as the direct participants. This reduces both operational and regulatory risk for direct participants, even before increasing the number of direct participants or moving to a centrally cleared model.

Interestingly, ICE reveals its view that even though the Gold price auction will not at this time use a centrally cleared model, this should not require the use of credit lines because until a centrally cleared model is introduced, “weaker credit names can be accommodated via pre-collateralisation.” The concept of credit lines is explained below and is another example of where the LBMA has avoided explaining the concept to the global gold public.

On its web site, ICE Benchmark Administration touches on the concept of sponsored clients:

Clients managing their own orders, sponsored by a direct participant – direct participants can choose to provide WebICE screens to their clients, allowing them to enter orders directly into the auction (orders still route through their sponsor/direct participant)….When client orders trade, their counterparty will always be their sponsoring direct participant.”

ICBC London
ICBC London
Bank of China, ICBC and China Construction Bank

At this point it’s worth highlighting that there are only three Chinese banks that could realistically become direct participants in the new LBMA Gold Price auction right now, namely, Bank of China, the Industrial and Commercial Bank of China (ICBC), and China Construction Bank (CCB). Bank of China is a commercial bank and should not to be confused with the People’s Bank of China (PBOC) which is the Chinese central bank.

The reason why only Bank of China, ICBC and China Construction Bank can join the Gold Price auction as direct participants is that these are the only three Chinese banks that are ‘Full’ members of the LBMA, and the LBMA, at a minimum, will not allow any non LBMA members to participate in the auctions as direct participants.

These three Chinese banks have full membership due to being ‘Ordinary’ members of the LBMA. The other category of full membership of the LBMA is of course the LBMA market makers, or which there are currently fourteen of these.

As explained below, these three Chinese banks qualify for directly participating in the recently launched LBMA Silver Price auction, so the Silver Price participant criteria are a good proxy by which to measure the eligibility of the Chinese banks to be direct participants in the LBMA Gold Price auction.

There are of course other giant Chinese banks that are major players in the gold market, such as Bank of Communications and Agricultural Bank of China, however, as they are not LBMA members or even LBMA associates, they would not be able to qualify to be direct participants under the LBMA’s strict and exclusionary auction participant rules.

LBMA Silver Price bait and switch operation

As a quick recap, the current scandal ridden London Gold Fixing which is being discontinued from 19th March is still, at the time of writing, being run twice daily by Barclays (who was fined by the FCA for manipulating the gold price in 2012 during the Gold Fixing),  HSBC, The Bank of Nova Scotia, and Société Générale. In April 2014, Deutsche Bank, which also held a seat in the Gold Fixing, resigned from the Fixing and renounced its fixing seat as of mid May 2014.

Deutsche bank then gave up its seat in the Silver Fixing on 14th August. When the new LBMA Silver Price auction was launched on 15th August last year (administered by Thomson Reuters with CME Group as the auction calculation agent), there were only three initial participants, namely, the HSBC Bank USA NA, Bank of Nova Scotia (Scotia Mocatta) and Mitsui & Co Precious Metals Inc.

Two of these participants, HSBC and Scotia, had been the incumbent members of the triumvirate London Silver Market Fixing Limited company, along with Deutsche Bank. Mitsui, the Japanese bank, in some ways just took the place of Deutsche Bank, or at least, that is how it was viewed in the media.

Despite misleading claims from the LBMA on August 15th that it “fully expects the list of price participants will grow over the coming weeksand that “these participants include banks, trading houses, refiners and producers”, this wider cross-sectional direct participation in the Silver auction never happened.

In a very low-key on-boarding process, only three additional entities joined the new Silver auction following the launch on 15th August, and all three of these entities were bullion banks that joined without the fanfare of press releases from the LBMA or press releases from the banks in question.

UBS joined the Silver auction on 26th SeptemberJP Morgan Chase Bank joined the Silver auction on 14th October, and The Toronto Dominion Bank joined the auction on 6th November.

What’s very interesting about these six banks is that they are all represented on the LBMA’s 10 person Management Committee.

The current Management Committee of the LBMA consist of Grant Agwin of Johnson Matthey (Chairman), Steven Lowe of Bank of Nova Scotia-ScotiaMocatta (Vice-Chairman), Peter Drabwell of HSBC Bank USA NA, Kevin Roberts of JP Morgan Chase Bank, Philip Aubertin of UBS AG, Robert Davis of Toronto Dominion Bank, Jeremy East of Standard Chartered Bank, Simon Churchill of Brinks Ltd, and Ruth Crowell (Chief Executive).

Note: Anne Dennison of Mitsui was appointed as a director of the LBMA on 25th September 2014, but then this appointment was terminated on 20th December 2014.

Readers may wonder if some or all of these six bullion banks were pre-selected or encouraged to participate by the LBMA even before the LBMA Silver Price auction was launched in August. The answer to that would be a definitive ‘Yes’, since, from as early as July 2014, the LBMA and the CME Group had already identified a group of 6 to 7 bullion bank ‘first tier participants’ that they had agreed would be the initial pipeline of benchmark participants to receive LBMA accreditation to take part in the new Silver auction.

This information was conveyed by CME to the London silver market during the CME’s pre-launch information and training sessions. As for wider silver market participation in the auction, this was never part of the phase 1 plan for the silver auction. Phase 2 of the Silver auction using a central counterparty clearing system was also quietly dropped by the LBMA and CME Group despite initial lip-service claiming such as a development was on the immediate horizon.

On 14th August 2014, a day before the Silver Price auction go-live, Reuters ran an article stating that while UBS was looking at the possibility of joining the Silver auction, the other giant Swiss Bank, Credit Suisse, would definitely be joining the auction:

Credit Suisse said on Thursday (August 13) that it would be taking part in the new process, while UBS said in an email that “it is currently evaluating the feasibility of becoming an auction member in the near future.”

In the end, UBS joined but Credit Suisse seems to have had a change of mind.

What are the chances that all six participants that did join the LBMA Silver Price auction would all be bullion banks that are represented on the LBMA Management Committee? Or said another way, what are the chances that six of the seven banks represented on the LBMA Management Committee (apart from Standard Chartered) would end up as the only participants in the new LBMA Silver Price auction? In a random world, the chances of that would be remarkably small.

China Construction CCB

“From a Controls Perspective”

Keeping in mind the above silver auction participant list of banks and this statistically improbable overlap with the make-up of the LBMA Management Committee, the Financial Times (subscription) published an interview with LBMA CEO Ruth Crowell on Monday 13th October 2014,  in which she said that:

several Chinese banks were also interested in joining the Silver Price alongside JP Morgan, HSBC, UBS, Mitsui & Co Precious Metals, and the Bank of Nova Scotia.”

Crowell told the FT that:

It will take some time from a controls perspective for them [Chinese banks] to get where they need to be. But I would imagine they will look to do both gold and silver simultaneously,” said Mrs Crowell. “It will make the London market that much more international.”

As to how much time equals ‘some time’, or what ‘controls perspective’ referred to, Crowell did not elaborate. As discussed below, there are no criteria from a ‘control perspective’ that the large Chinese bank members of the LBMA would not qualify under to participate directly in the gold and silver auctions.

However, it’s notable above that there was an LBMA view that the Chinese participants would join both the Gold and Silver Price auctions at the same time.

On Tuesday 14th October, the day after the above FT interview was published, the Bullion Desk also published an article about the interest by the Chinese banks in the new London daily fixings, in which it stated:

Several Chinese banks are set to join the London Bullion Market Association’s (LBMA) gold and silver pricing benchmarks, with a spokesman indicating that they are simply waiting for the administration to be decided.

A handful of Chinese banks indicated to LBMA chief executive Ruth Crowell during a recent visit to China that they would like to take part in the daily silver pricing benchmarks, the spokesman said.

The interested parties are, however, waiting to discover who will be awarded the administration of the gold pricing benchmark before also taking part in the twice-daily gold pricing sessions, he added.”

The Bullion Desk article again refers to the Chinese wanting to participate in both the Silver and Gold daily auctions, but even more interestingly, it appears that the Chinese banks placed a high value on knowing which administrator was going to run the Gold Price auction.

Its unclear why the Chinese would be so concerned about the identity of the auction administrator. It’s possible they did not approve of one administrator i.e. CME Group, running both auctions. It may also have been a red-herring on the part of the LBMA to raise this as an issue, however now that this information is known, i.e. ICE Benchmark Administration, it would be interesting to know how the Chinese view this outcome.

Finally, in the same week, on Friday 17th October 2014, in an interview with Metal Bulletin (subscription) titled ‘LBMA chief on the new era of precious benchmarking’, LBMA CEO Ruth Crowell said:

“Among those that are interested in participating in the discovery processes are several Chinese banks that the LBMA recently met in China.

These were initially interested in contributing to gold price discovery, but then said they would like to get involved in the silver process, Crowell said.

“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 and that they’d look to get involved in silver as well,” she added.

“We spoke about what we did with regard to silver and how we had started the process for gold, so the natural question was, well, will it be more open? There will be more participation. There will be levels of transparency [in gold] that you are seeing with the silver auction,” she said.”

So, the LBMA has gone on record as stating that the Chinese ‘definitely’ want to be participants in the LBMA Gold Price auction on Day one (which is 20th March 2015).

mao

Chairperson Who?

If the Chinese had indeed been curious as to which administrator would be chosen to run the Gold Price auction, perhaps they will be curious about the fact that ICE Benchmark Administration has just announced that over the short-term, it is planning to employ a human (as opposed to an automated) chairperson in the daily Gold Price auctions. However, ICE will not reveal at this time who they have selected as this chairperson. The identity of the chairperson will only be revealed on launch day, 20th March.

The chairperson’s role in the auctions is to “set the starting price and the price for each round based on a set of rules that will be pre-determined and publicly available.”

ICE Benchmark Administration (IBA) state that:

IBA has appointed a chairperson for Day 1. In due course, IBA will evaluate developing an algorithm, in consultation with the market. The chairperson has extensive experience in the gold market, and is appointed by IBA and therefore independent of the auction process.”

Again, to reiterate, ICE will not reveal publicly until launch day as to who this chairperson is. With “extensive experience in the gold market”, it would be unfortunate and probably unacceptable to many entities in the wider global gold market (including the Chinese banks) if this chairperson (for example former Barclays director of the London Gold Market Fixing Limited Jonathan Spall), was closely connected to the LBMA or closely connected to one of the LBMA bullion banks or the soon to be discontinued Gold Fixing, since that would not demonstrate the degree of  independence that IBA is claiming.

Spall
Jonathan Spall, ex Barclays
The Participant Criteria

The main requirement for Bank of China, ICBC and China Construction Bank in becoming participants in the LBMA Gold Price auction at launch on Day 1 would be for them to meet the LBMA’s Participant criteria as well as ICE Benchmark Administration’s Participation criteria.

Given that the LBMA and IBA have not yet published these Gold Price auction criteria in the form of a methodology guide, the best approach right now is to look at how the Chinese banks would fulfill the participant and participation criteria that were formulated in July/August 2014 for the LBMA Silver Price auction. Since, as explained above, the Chinese banks actively want to participate in the daily Silver Price auction, they will have to go through this application process anyway.

Additionally, the Silver Price accreditation criteria can be assumed to be very similar to the criteria of the Gold Price auction since the two auction processes are basically identical.

In August 2014  a document titled Commodities Benchmark Methodologies: LBMA Silver Price was published under the name of Thomson Reuters, the administrator of the LBMA Silver Price benchmark. This methodology guide was jointly written by the LBMA, Thomson Reuters, and the CME Group and discusses the methodology that the three partners have established for the silver price benchmark, including the criteria that qualifies an applicant to be authorised as a silver auction participant.

This LBMA Silver Price Methodology document states that:

Participation in the auction is open to all silver market participants who meet the following conditions:

- meet the Benchmark Participant criteria set out by the LBMA

- meet the Participation criteria set out by Thomson Reuters as the Administrator

- meet the requirements set by CME Benchmark Europe Ltd to use the technology platform and participate in the auction market place.

The market participants are accredited by the LBMA; access to the auction platform is approved by CME Benchmark Europe Ltd.

It’s critical to note that these three sets of criteria/requirements are the official basis under which the LBMA plays the role of gatekeeper in deciding which applicants to allow to join the Silver Price auction process, and which to keep out. It’s also important to note the distinction between participant criteria and participation criteria:

And now the most important part. The LBMA’s Benchmark Participant criteria for the Silver auction are as follows:

  • A participant has to be a Full Member (Ordinary or Market Making) of the LBMA.
  • The participant also needs to have a Loco London Clearing account
  • Applications are subject to review and ultimate approval by LBMA
  • The participant has to accept and implement the Thomson Reuters LBMA Silver Price Participant Code of Conduct
  • Participation is additionally subject to the requirements set by CME Benchmark Europe Ltd for use of the technology platform and for participation in the auction (e.g., in respect of credit arrangements)
Meeting the Criteria

All three Chinese banks, i.e. Bank of China, ICBC, and China Construction Bank are already Ordinary members of the LBMA. Bank of China has been an ordinary member of the LBMA since at least 1999. See LBMA member list here from August 1999. Industrial and Commercial Bank of China (ICBC) became an ordinary member of the LBMA in late 2011. On 7th October 2014, China Construction Bank was admitted as an Ordinary member of the LBMA.

So, all three Chinese banks, as Ordinary members of the LBMA, are also Full members of the LBMA, and therefore fulfill the first criterion to be direct participants in the auction.

By definition, to become an Ordinary member of the LBMA  “members must be companies or organisations which are actively involved in the London bullion market. For entities which trade, this means trading gold or silver bullion or related derivatives such as forwards and options in the loco London market.” Additionally an Ordinary member, when trading bullion and derivatives has to trade “in the loco London market with at least three existing members.”

So, given that the three Chinese banks are Ordinary members of the LBMA, by definition they trade, settle and clear gold and silver in the loco London market and by definition they maintain loco London clearing accounts. This fulfills the second criterion for direct participation in the auctions.

All Full members of the LBMA (Ordinary and Market Making members) have to pass ‘know your customer’ (KYC) procedures and ‘declare conformance with the Non-Investment Products Code’ before being accepted as members. Again, by definition, the three Chinese banks fulfill these requirements also since they are already Ordinary members.

Therefore, to become direct participants in the auction, the three Chinese banks would just need to receive LBMA approval and sign up to the ICE auction platform and its participation criteria, which would essentially refer to adopting something that could be called the Gold Price Participant ‘Code of Conduct’, which is just a subset of IOSCO benchmark principles that specifically address ‘code of conduct’.

In the IOSCO Principles, there is a “Submitter Code of Conduct”, which states:

“The Administrator should develop guidelines for Submitters (“Submitter Code of Conduct”), which should be available to any relevant Regulatory Authorities, if any and Published or Made Available to Stakeholders.”

And given that the Financial Conduct Authority (FCA) has decided very recently that the participants in the Silver and Gold Price auctions are not even defined as submitters, then the codes of conduct are even less severe than, for example, in the new LIBOR process. Adhering to the Code of Conduct just allows the administrator (IBA) to maintain a set of internal controls in the auction platform that allows for the collection of the price inputs in an IOSCO compliant way.

In summary, there is nothing in the LBMA participant criteria or administrator participation criteria to exclude Bank of China, ICBC and China Construction bank from being direct participants in the LBMA Gold Price and Silver Price auctions.

One final point on this matter is that the new gold and silver auctions, like the old gold and silver fixing auctions, make use of bilateral credit lines between all of the auction participants. What this means is that to participate in the auctions, an entity has to have large credit lines set up with all other participating entities, which essentially creates a mutual pool of credit, and all the participants share this pool of credit.

The LBMA could easily have introduced a central clearing platform for the trades in the new auctions so as to have prevented the need for large credit lines (both the ICE and the CME systems allowed this, as did the LME solution), but the bullion banks chose to ignore this solution, and are conveniently using the need for credit lines as an excuse to keep out smaller participants who might want to participate directly, such as refiners, miners etc but who do not have credit lines established.

It also conveniently protects  and ring-fences the London Precious Metal Clearing Company’s AURUM unallocated metal clearing platform which is another critical point, but beyond the scope of this current discussion.

Again however, the large Chinese banks would have no problem running large credit lines with the other bullion bank participants, since Bank of China, ICBC and China Construction are some of the largest banks in the world with very high investment grade credit ratings and strong tier 1 capital ratios.

SGE ceremony

 The Big 3 in London

Let’s look at the three Chinese banks that are Full Members of the LBMA, i.e. Bank of China, ICBC, and China Construction.

All three of these Chinese banks have their UK headquarters in the City of London, near the Bank of England and incidentally very near the LBMA’s offices also. Bank of China is at 1 Lothbury, China Construction is at 111 Old Broad Street, and ICBC is at 81 King William Street. These three locations form a triangle, and are literally 5 minutes walk from each other, and coincidentally, the LBMA offices at Royal Exchange Buildings are right at the heart of this triangle.

China Construction Bank

China Construction Bank became an ordinary member of the LBMA on 7th October 2014, and is classified by the LBMA as a bank entity (as opposed to a broker) and is categorised under country classification of China. China Construction’s headquarters is in Beijing.

China Construction Bank (London) Ltd had been based at Heron Quays in Canary Wharf (east of the City) but in June 2014, the Bank purchased a building at 111 Old Broad Street, in the City (of London) to use as its new European headquarters.

On its London website, China Construction Bank (CCB) states that:

“We are also active in money market business and provide a Euro time zone platform for CCB’s foreign exchange and precious metal trading.

CCB is active in the offshore RMB market and in 2012 received the designation as the “first clearing bank outside Asia for the Chinese currency”. In June 2014, CCB was also designated by the Chinese central bank as the London RMB clearing bank. CCB London is the 2nd largest Chinese bank in the UK.

In 2013, CCB was ranked 5th in the “Top 1000 World Banks” by the Banker Magazine, and ranked as 2nd by the Banker in 2014.

There are two CCB entities in the UK, China Construction Bank (London) Limited, regulated by the Financial Conduct Authority effective from 09/03/2009, and China Construction Bank Corporation London Branch regulated by the Financial Conduct Authority and Prudential Regulation Authority effective from 22/12/2014

Both CCB entities are permitted to arrange, deal and transact in investments in the UK including commodities.

Although China Construction Bank Corporation was authorised by the FCA and PRA on Monday 22nd December, it only announced this authorisation in a press release on 2nd February 2015,

“On 22 December 2014, the UK’s Prudential Regulation Authority (PRA) and Financial Conduct Authority (FCA) officially approved the establishment of China Construction Bank Corporation, London Branch…..  Concurrently, the application for a Whole-firm Liquidity Modification waiver for the branch has been approved.”

Industrial and Commercial Bank of China (ICBC)

ICBC is an Ordinary Member of the LBMA and was admitted as an ordinary (Full) member of the LBMA in late 2012. See press release 23rd December 2012. ICBC is classified by the LBMA as a bank, and is categorised under country China, with its headquarters in Beijing.

On its London website, in a December 2012 press release titled “ICBC Is the First Chinese Bank to Quote Precious Metal Prices and Match Deals in Global Market“, the Bank states that:

ICBC provides real-time prices to worldwide buyers and sellers of precious metals including gold or silver in Beijing, London and New York round the clock.

ICBC also runs two main UK entities  ICBC (London) plc, regulated by the Financial Conduct Authority and Prudential Regulation Authority effective 01/04/2013, and Industrial and Commercial Bank of China Limited, regulated by the FCA and PRA effective 08/09/2014. Both entities are permitted to arrange, deal and transact in investments in the UK including commodities.

Lothbury

Bank of China

Bank of China is a Full ordinary member of the LBMA, is classified as a bank by the LBMA, and interestingly, in the LBMA schema is categorised by the LBMA under country UK, and not China. Its Headquarters is 1 Lothbury, which is the street behind the Bank of England. Bank of China issued RMB bonds though its London branch in January 2014. This followed similar RMB issuance from ICBC and CCB.

Bank of China has been an ordinary member of the LBMA since the 1990s. On its London website it states:

“The major currencies that we can provide for FX spot are: Australian Dollar (AUD), Canadian Dollar (CAD), Swiss Franc (CHF), Chinese Renminbi (RMB)….etc…etc… Swedish Krona (SEK), U.S. Dollar (USD), Singapore Dollar (SGD), Silver (XAG), Gold (XAU), South African Rand (ZAR), etc.

There are similar statements for Swaps and Forwards.

There are three Bank of China entities in the UK. Bank of China (UK) Ltd Bank of China Limited, and Bank of China International (UK) Ltd, which are, to various extents, regulated by the FSA and the PRA.

All three Bank of China entities are permitted to arrange, deal and transact in investments in the UK including commodities.

The 11 to 13 Entities

On 7th November 2014, upon announcement of ICE (IBA) being ‘selected’ as administrator of the LBMA Gold Price, Ruth Crowell saidwe are pleased to have eleven entities intending to be Phase One Participants.” These entities (bullion banks) had signalled their interest to the LBMA before, during and after the period from October 24th (an LBMA closed-door seminar about the new gold auction and the various proposals) up to 4th November (LBMA committee meetings to discuss the vote and agree on the winning entry). The “Phase One Price Participants” as the LBMA refers to them, were also involved in these discussions in and around 4th November.

Since this announcement about the “eleven entities intending to be Phase One Participants” was only three weeks after Crowell’s statement that “it will take some time from a controls perspective for them [Chinese banks] to get where they need to be”, this would suggest that the Chinese banks were not part of this group of 11 phase one participants.

While covering the LBMA’s conference in Lima, Peru which was held over the two day period 11th – 12th November, Bullion Desk, who were at the conference, quoted Finbarr Hutcheson, ICE Benchmark Administration president, as saying:

During the consultation process, 11 companies came forward as prospective direct participants. And over the past two days we’ve heard from two more, bringing the total up to 13.”

The same article quoted Ruth Crowell as saying:

“The London Bullion Market Association (LBMA) has already received interest from 13 banks or other firms looking to become direct participants in the new gold price benchmark auction.

We’re now actively recruiting because the last thing we want is for everyone to be staring at a blank screen on that first day. Bringing participants on-board is our number one priority,” Ruth Crowell, LBMA chief executive, said on Monday at the association’s conference here.”

However, and this is an important point, there were no representatives from Bank of China, ICBC, or China Construction in attendance at the LBMA’s Lima conference in November, so the 2 additional interested parties that expressed an interest during the conference were by definition not Chinese, unless they had contacted IBA remotely while the IBA and LBMA executives were in Lima, which seems highly unlikely. See 2014 conference delegate List pdf, and also another version here.

It would be unusual for Chinese banks to be planning to imminently join the Gold Price and Silver Price auctions but not attend the LBMA conference, since this conference was attended by senior executives of the winning administrator, ICE Benchmark Administration, as well as senior representatives from the CME Group and Thomson Reuters.

Small delegations from some Chinese banks did chose to go to the LBMA’s Singapore Bullion Market Forum in June 2014. Here, ICBC’s Zhou Ming, General Manager, Precious Metals Department actually made a presentation, and other ICBC precious metals staff, as well as China Construction staff, attended, but no one from Bank of China.

There was one Bank of China senior executive, Steven Haydon, at the 2013 LBMA annual event in Rome. The LBMA’s 2012 Conference, which was held in Hong Kong, was attended by Yan Wang of Bank of China, London, as well as Xiaoyang Liu and Zheng Zhiguang of ICBC China. But overall the attendance of Chinese Bank delegates at these LBMA conferences over recent years has been patchy at best.

Who approves the Direct Participants? The LBMA!

In its FAQ document, ICE also explains that there is an LBMA Gold Price Oversight Committee, and reveals that “the first meeting of the LBMA Gold Price Oversight Committee was held on February 27, 2015″.

According to the FAQ, one of the roles of this Oversight Committee is to approve the criteria for new direct participants:

“The LBMA Gold Price Oversight Committee’s responsibilities include conducting regular reviews of all aspects of the determination of the LBMA Gold Price, overseeing any changes, setting and overseeing the rules and practice standards, approving the criteria for new direct participants and overseeing IBA’s adherence to its published methodologies”.

The ICE executive summary of its proposal for the Gold auction goes even further and says that:

“It is through the Oversight Committee that the LBMA will continue to have significant involvement in the auction process, including, among many other things, changes to the methodology, approval of direct participants, and the decision on whether to move to a centrally cleared model (until that time, weaker credit names can be accommodated via pre-collateralisation).”

So although the Oversight Committee is responsible for “approving the criteria for new direct participants”, the LBMA is responsible for the specific “approval of direct participants”. There is a difference.

Why is there an Oversight Committee and what type of entities are on the committee? Again, the ICE proposal explains:

“Under the UK benchmark regulation, the governance structure for a regulated benchmark must include an Oversight Committee, made up of market participants, industry bodies, direct participant representatives, infrastructure providers and the administrator.

At the time of writing, neither ICE nor the LBMA have published any details of the identities of the members of the Oversight Committee or who they represent, nor have they published any agenda or minutes of the first meeting that took place on 27th February. And this is the new world of transparency for the LBMA Gold Price?

Robustness
Who will the 11 – 13 entities be in the Gold Price auction?

It should be noted that in the new Silver and Gold auctions, the participants take part for their own bullion trades and those of their clients, and they are not obliged to represent other non-participant entities. So, for example, if bullion bank A is a participant in the new gold auction, it does not have to take gold fixing orders from bullion bank B for the fixing. Bullion bank B is expected to apply to become a participate itself (unless the LBMA don’t let them participate). The wider and more extended the participation, the more robust the data.

It is quite obvious that the vast majority of the 11-13 entities on Day 1 in the new Gold Price auction (if there are even that many taking part), will be the existing LBMA Market Makers.

In coverage by the Financial Times on 11 July, the day on which the LBMA awarded the CME Group and Thomson Reuters the contract to run the new Silver Price auction, the Financial Times said the following:

Since there is no centralised clearing for precious metals markets, initial users of the new silver benchmark are likely to be the 11 LBMA spot market making members, including JPMorgan, Goldman Sachs and UBS. They can currently only trade through the fixing members.”

On 12 August, just before the launch of the LBMA Silver Price auction, the Financial Times again highlighted this key point about the lack of central clearing in the CME Group’s Silver Price platform, when it stated in nearly the same language, but adding in JP Morgan:

Since there is no centralised clearing for precious metals markets, the initial users of the new benchmark are expected to be the 11 market making members of the LBMA, which include Credit Suisse, JP Morgan, Goldman Sachs, and UBS”.

Therefore, using a list of the LBMA Market Makers is a very good starting point for estimating the identities of the inner core of LBMA bullion banks that in all likelihood will make up the bulk of the 11 – 13 ‘Day 1′ ‘direct participant’ entities in the Gold Price auction.

This is notwithstanding the fact that, again, there was no need for the LBMA not to introduce a centrally cleared model on Day 1 so as to broaden participation, and also since as ICE said, until a “move to a centrally cleared model”, was introduced “weaker credit names can be accommodated via pre-collateralisation”.

Starting with the four existing banks in the current gold fixing, who are sure to re-enter the new auction, the first names on the 11-13 list are Barclays, HSBC, Scotia Mocatta, and SocGen. Since Deutsche Bank left the table, it would be surprising if Deutsche came back to the new gold auction so soon. Therefore I am leaving Deutsche off of my list.

Next to add to this list would be JP Morgan. JP Morgan is one of the six precious metals clearers in London in LPMCL, it runs an LBMA precious metals vault in central London, and it is a participant in the Silver auction.

Next add UBS and Credit Suisse, two huge players in the gold market, especially in Switzerland. Next up would be Goldman Sachs (J. Aron) which is a large player in the gold market and Mitsui, an existing participant in the Silver auction.

All of these banks trade spot market make in the London gold market. I would leave out Bank of America Merrill Lynch for the moment, for no particular reason except it only market makes options in the London gold and silver market.

Fast-Tracking Market Makers into the Gold auction?

To become an LBMA market maker, an Ordinary member LBMA bank has to undergo a three-month probationary period, during which it has to quote bids and offers in silver and gold to all other LBMA market makers. More importantly, all of the other market makers must approve the appointment of a new LBMA market making member.

In a very under covered story, three additional bullion banks very recently became LBMA market making members, namely Citibank, Morgan Stanley and Standard Chartered.

‘Officially’, this 3 month probation is the process that Citibank NA, Morgan Stanley & Co International and Standard Chartered would have gone through recently before they were all successfully reclassified as LBMA market making members in late 2014 and early 2015, which increased the number of LBMA market makers from 11 to 14.

On 25th September 2014, Citibank N.A. was reclassified as a spot LBMA Market Maker for spot and options. On 16th October 2014, Morgan Stanley was reclassified as a LBMA Market Maker for spot and options. On 9th February 2015, Standard Chartered was appointed as a LBMA market maker for spot and options.

This flurry of activity of Ordinary member bullion banks being reclassified as LBMA market making members is unprecedented and suggests that these three banks may have been preparing in some way to be participants in the LBMA Gold Price auction. That’s a 27% jump in the number of market makers from 11 to 14 in five months, with all 3 occurring in the run-up to the launch of the new Gold Price auction.

Before these three reclassifications, the previous transitions by an Ordinary member to become a market maker were Merrill Lynch in 2011, Credit Suisse in 2010, and Mitsui in 2007. That was three new market makers over four years as opposed to three over five months.

Of the 14 current market makers, 13 are spot market makers but only five of these banks make markets in the three products: spot, forwards and options. These banks are HSBC, UBS, JP Morgan, Goldman Sachs and Barclays.

In 2006, the LBMA rules on market makers were altered so that a market maker didn’t have to make markets in all three products.

The other nine banks make markets in one or two of the three products. Credit Suisse, Scotia, SocGen, Standard Chartered, Deutsche, Mitsui, Citi and Morgan Stanley are market makers in spot markets. Scotia also market make in forwards, while Credit Suisse, Deutsche, Standard Chartered and Morgan Stanley also trade options as market makers. Mitsui, SocGen and Citi just do spot market making. Merrill Lynch is only a market maker in options, and notably, does not do spot.

I would add the three newcomer market makers of Citi, Morgan Stanley and Standard Chartered to the ‘direct participant’ list for the Gold auction, since their transitions to market maker status could well be related to some LBMA criteria whereby the LBMA have decided to fast track market makers into the Gold auction.

The running total at this stage is 12 bullion bank entities, and no ‘Ordinary’ bank members have yet been considered.

A few of the above may not be on the list. Likewise, other bullion banks such as Commerzbank, Natixis, ANZ, Standard Bank or BNP Paribas may well be on the list. Until LBMA and ICE actually publish the list, the only alternative is to speculate.

What you can take away from this guessing game list however is that the numbers of 11 and 13 entities being thrown around in November of 2014 by the LBMA and ICE probably did not include the Chinese banks. That is not to say that things might not have moved on since last November and Chinese banks may now be on the direct participant list. A series of delays in launching the Gold Price auction may indicate that participant negotiations were still going on behind the scenes.

Multiple Delays in Launch

The expected launch date for the Gold Price auction was pushed back a number of times between November 2014 and February 2015. One possibility for the delays, in my view, was due to ongoing or reignited negotiations with the Chinese banks. Following the LBMA’s closed-door ‘Market Seminar’ on 24th October, the LBMA said that the new gold solution would be implemented in December/January (see page 4 of presentation). Then in the LBMA’s Lima Conference slides from 11th November it said that the implementation time-frame would be January/February (see timeline in presentation page 2 – Implementation expected for January/February).

An article in Metal Bulletin (subscription) on 4th December titled “February launch likely for new gold price mechanism” quoted Ruth Crowell, as saying:

“‘Mid-February is estimated for the [launch]. We’ve said that is a comfortable deadline, but if it can happen sooner, then great,’ Ruth Crowell, ceo of the LBMA, told delegates at the Mines and Money conference.”

However, there was no other LBMA or ICE public reference to the Gold Price auction again for nearly two months when, on 2nd February, ICE issued a press release in which it said that “the new LBMA Gold Price…is expected to be launched in March 2015“, without providing a definite date or an explanation for the delays.

The actual launch date was only confirmed on 19th February when the LBMA announced that the auction would be launched on 20th March. Then the first LBMA Gold Price Oversight Committee meeting took place on 27th February.

Some people might point to a letter that the LBMA sent to the FCA, dated 30th January, in which it highlighted some regulatory confusion from an FCA paper called CP14/32 about whether the participants in the Gold Price auction would be treated as benchmark submitters or not, and about which the LBMA claimed that lack of clarification on this issue would cause delays in potential participants signing up for the auction.

ICE confirmed to me however that participant sign-off was an internal matter for the participants and they did not appear to think that this submitter matter was an issue.

Anyway, the FCA confirmed in policy statement PS15/6 that this submitter definition was not applicable to the Gold Price auction, so it did turn out to be a non-issue, and does not explain why the launch date has been delayed so long. The gold and silver market knew from August 2014 when the “Fair and Efficient Markets Review” recommendations were published, that the gold and silver price benchmarks were in scope for FCA regulation from 2015.

In the FCA’s policy statement PS15/6, the FCA added “additional perimeter guidance to clarify further who in our view is, or is not, a submitter, and in particular, in respect of auction participants”. Specifically, the FCA said:

“a person who, in the context of an auction or otherwise, submits bids or offers solely for the purpose of transacting in a commodity or financial instrument or any other asset for their own, or their client’s, behalf will not normally be providing information in relation to a specified benchmark” (2.7.20E (A) G) (Annex E – Amendments to the Perimeter Guidance manual: specified benchmark activities)

Therefore, participants in the LBMA Silver Price and Gold Price auctions are not classified as benchmark submitters, and do not have to be regulated as such, so there is no reason why this should now hold up or delay approval of any direct participants for the Gold Price auction.

As the LBMA said itself on 2nd February:

“The systems and controls that the Administrator puts in place for non-submitters, namely, the criteria that must be met to participate, the contractual framework, for example the rulebook, participants agreement and code of conduct, should provide appropriate controls to maintain the integrity of these non-submission based benchmarks.” (i.e. the LBMA Gold and Silver Price auctions)

Despite all the above regulatory questions being answered and having had at least 4-5 months of advance preparation to join the new auction, the LBMA is now making more soundings that “Not all participants in ICE gold benchmark will be in place ‘on day one’.

This latest update come from Bullion Desk, who state:

“Some of the parties intending to participate in the new ICE gold benchmarking process may not be able to do so in the first auction on March 20, the LBMA has confirmed.

Internal sign-offs, regulatory procedures and credit lines with other participants may not be completed in time, it said.

New participants unfortunately don’t have the framework in place like the current members of the London Gold Fix do,” an LBMA spokesman said. “The current members were ahead of the game on that front.”

‘It’s fair to say that we will likely have more participants involved after the initial launch. We can’t guarantee that all interested parties will be there on day one,’ he added.”

I think it is fair to say there a lot of hoops for new participants to jump through,” the spokesman added.

This is another astounding part of the entire Gold auction participant drama, that the LBMA is now saying that regulatory procedures and credit lines, and “a lot of hoops” are delaying participants from completing what should really have been a very simple open and transparent process to allow any credible gold market participant worldwide to sign up and participate in an open and transparent new gold price discovery process.

New participants unfortunately don’t have the framework in place like the current members of the London Gold Fix do” according to the LBMA. Isn’t that the whole point, that participants should not need any existing framework to take part? The old London gold fix has been proven to have been corrupted and manipulated. There should be no legacy connection to it in the new system and no excusing from the LBMA or anyone else that potential participants are in some way dis-advantaged because they were not part of the old five fixers club. This is truly unbelievable.

And why should there be “a lot of hoops for new participants to jump through”? The entire fiasco is starting to look like it was designed by the LBMA to be as complex as possible so as to deter new participants from joining the auctions as direct participants.
Standard ICBC
ICBC and Standard Bank

Which brings us back to the Chinese banks. Bullion Desk said on 12th March 2015 in the same update as above that:

“Among others, several Chinese banks are said to be interested in joining some of the traditional members of the current fix in the new system.

Rumours have circulated that one of those banks is Industrial and Commercial Bank of China (ICBC), one of the biggest banks in the world and a major participant in the gold market.”

When Deutsche Bank was attempting to sell its Gold and Silver Fixing seats early in 2014, ICBC was eager to secure Deutsche’s Gold Fix seat through its interest in Standard Bank of South Africa. ICBC was also at that time rumoured to be interested in becoming a market making member of the LBMA. Neither of these events ever materialised however.

On 18th February 2014, Reuters reported that:

South Africa’s Standard Bank, now selling a controlling stake in its markets unit to China’s ICBC, is emerging as a frontrunner to buy Deutsche Bank’s place in the global gold price-setting process, sources familiar with the matter said.”

“Market sources said Standard Bank, in conjunction with ICBC, is in prime position to buy the Deutsche seat. ‘Standard Bank is a shoo-in for the fixing seat – they want it, and it would be acceptable to the other members,’ a senior gold market source told Reuters. ‘It’s just whether they can agree a fee.'”

“‘ICBC have wanted to be a market-making member of the LBMA for a while,’ said another senior gold market source, who saw the bank as having potential interest in the fixing seat.

The same article also pointed out that the previous time a Gold Fixing seat was sold was in 2004 when Rothschild sold its seat to Barclays for the princely sum of $1 million; small change for a giant Chinese bank such as ICBC.

However, on 28th April 2014, Reuters reported that Deutsche Bank had resigned its gold seat since, according to one of their sources:

“It was a case of not being able to agree on terms”.

It seems hard to believe that there was an inability to agree on the price of Deutsche’s Gold Fix seat, given the deep pockets of all the parties concerned. Some other factors must have been at play. Could it have been that the London Fixing banks did not want ICBC (through Standard) to purchase the seat?

It’s very unusual that given ICBC’s desire to become an LBMA market maker, that it has not yet done so, especially considering the rush by Citi, Morgan Stanley and Standard Chartered to become market makers in the last few months.

Even as early as May 2012, ICBC said that it wanted to become an LBMA market maker:

“‘We hope to play a bigger role in the global precious metals market and become a major market maker, like Barclays,’ Shen Shisheng, ICBC vice-general manager of financial markets, told Reuters on the sidelines of a conference in Shanghai.”

Standard Bank Plc, classified under the UK, is also an Ordinary member of the LBMA. On 2nd February 2015, ICBC announced that it acquired 60% of Standard Bank Plc:

The Industrial and Commercial Bank of China (ICBC) announced on Monday the acquisition of a 60-percent stake in Standard Bank Plc.

Based in London, Standard Bank Plc is the international commodities and foreign exchange arm of Standard Bank Group (SBG), the largest African banking group by assets.”

ICBC already owns 20% of the Standard Bank Group. With this new 60% acquisition of a commodities and fx business through Standard Bank Plc, ICBC could well be planning to join the Gold Price auction via the Standard Bank route.

ICBC were also rumoured to be interested in purchasing Deutsche’s empty precious metal vault in Park Royal, London, which is operated by G4S, which could be another interesting development for the Chinese bank as a route into becoming a member of London Precious Metals Clearing Company (LPMCL).

ICBC seems to be clearly indicating that it is ready and willing to be a direct participant at day 1 launch on 20th March. Chinese newspaper, China Daily, in a 3rd March article titled “More Chinese banks to take part in setting the global gold price” stated that:

“ICBC confirmed it had already laid the foundations for its participation in a press release on Monday.”

Monday here refers to Monday 2nd March. There will undoubtedly be a sense of shock and injustice if the LBMA and ICE do not include at least one or two Chinese banks, such as ICBC, on the list of day 1 participants, which, don’t forget, is only being published on launch day, and not before.

The LBMA Gold Price auction should comprise a broad participation auction of banks, trading houses, refiners, miners, jewelers and other gold market participants trading as direct participants if they so choose. It should not be a narrow auction made up solely of incumbent London-based bullion banks which is a system that has proven to have been manipulated and was successfully prosecuted by the FCA.

With prolific LBMA bullion bank representation on the Shanghai Gold Exchange including UBS, Goldman Sachs, Scotia Mocatta, Standard Chartered, HSBC, ANZ, Natixis, and the opening up of the Chinese gold market and Shanghai Gold Exchange to foreign banks, it would be unfortunate if a series of LBMA Gold Price structural barriers such as credit lines, FCA regulatory issues, and ‘a lot of hoops to jump through’ provided the LBMA Management Committee with an excuse not to approve the large Chinese banks to directly participate in the LBMA Gold Price auction on Day 1 on Friday March 20th.

The IMF’s Gold Depositories – Part 2, Nagpur and Shanghai, the Indian and Chinese connections

Part 1 of the IMF’s Gold Depositories series explained the legal background as to why the IMF originally made the decision to hold gold at the Federal Reserve Bank of New York, the Bank of England, the Banque de France and the Reserve Bank of India.

See Part 1 for details, but as a quick recap, although the current IMF Rule F-1 on the location of its gold depositories states that “Gold depositories of the Fund shall be established in the United States, the United Kingdom, France, and India”, the original 1946 version of the rule, then called Rule E-1, said that “Gold depositories of the Fund shall be established in New York, London, Shanghai, Paris, and Bombay.

It is generally known that the central banks in some of these cities are indeed locations are IMF gold depositories, and the IMF will actually, on occasion, bring itself to confirm these facts.

What is less well understood however are the references to the cities in two of the word’s great gold markets, specifically, the reference to the Reserve Bank’s Bombay office, the transfer of IMF gold to another Indian city, Nagpur, and the fact that Shanghai was only removed “temporarily” and could, in theory, be reinstated as an IMF gold depository.

The Road to Nagpur

The original version of Rule E-1 was adopted on 25th September 1946, and then amended in 1956. This amendment in 1956 was triggered by the Reserve Bank of India (RBI), but it created some far-reaching implications for where the IMF’s gold can be stored.

The trigger for the amendment of Rule E-1 in 1956 was an initiative by the RBI to move their own gold from their Bombay office to a new office in Nagpur which they had just opened. Nagpur is a city in the very heart of India in the state of Maharashtra.

Nagpur in India
Nagpur, at the heart of India

In moving their own gold, the RBI asked the IMF if it objected to the re-location of the IMF gold at the same time. There was actually not much IMF gold held in Bombay, the only gold held there being India’s initial gold subscription to the IMF that had been transferred at the Fund’s inception, worth $27.5 million at $35 an ounce, or just over 24 tonnes. No other founding nation of the IMF had supplied gold to Bombay at that time.

In a 1956 staff document to the IMF Executive Directors, “Gold Depositories of the Fund”, the IMF staff explained the RBI’s move and recommended that the wording of Rule E-1 should be made more flexible so as to take account of future situations where other gold depositories of the Fund might want, or need, to hold gold at alternative locations in their respective countries, other than those locations already specified.

The IMF staff also proposed to the IMF Executive Directors that they should agree to the RBI’s request:

At the moment, the Fund holds the equivalent of US$27.5 million in gold with the Reserve Bank of India in Bombay. The Fund has received a letter from the Reserve Bank stating that it has recently opened an office at Nagpur, which is situated about 520 miles from Bombay in the interior of the country.

The office is in the Bank’s own building, and it contains a special vault for storing the Bank’s stock of gold. The special vault was constructed partly to enable gold to be stored at a comparatively safer place and partly to relieve the pressure on vault accommodation at the Bombay office. The Reserve Bank is transferring its own gold to Nagpur and inquires whether the Fund would object to the movement of the Fund’s gold.”

The staff document went on to explain the logistics of the move:

“The arrangements for transport would be made under the supervision of the military, and safe custody arrangements at Nagpur would be subject to the same security conditions as are observed at present in Bombay. The Fund’s gold would continue to be held under earmark, and the normal procedures which gold depositories follow in relation to the Fund would continue to be observed.”

A critical point in this IMF document, beyond the Indian gold transfer, is that the IMF staff viewed it as an opportunity to propose more general wording for Rule E-1 so as to allow IMF gold to be stored in any location within the designated countries. The Staff proposed to the Executive Directors.:

“Although Rule E-1 is not free from ambiguity, the more obvious reading of it requires that gold held in India shall be held in Bombay.

The question of the physical transfer of gold may be raised by other gold depositories of the Fund. For example, in the United States, there have been occasions when official stocks of gold have been held simultaneously in New York, Denver, San Francisco and Fort Knox.

The staff believes that it would be advisable to amend Rule E-1 so as to give the Fund more flexibility in dealing with a proposal of the kind made by the Reserve Bank of India. Accordingly, it recommends that Rule E-l should be amended…”

(Source: EBS/56/39, “Gold Depositories of the Fund”)

An IMF Executive Board meeting in November 1956 about the move of the Fund’s gold to Nagpur, approved on January 9th, 1957 (Meeting 57/1),  deemed that “it is agreed that the Fund’s gold held with the Reserve Bank of India shall be held at Nagpur.”

The Executive Directors also used the opportunity of the 1956 amendment to Rule E-1 to delete the reference to Shanghai as an IMF gold depository (‘without prejudice’). This is explained below.

And so, in 1956 the Rule E-1 sentence

Gold depositories of the Fund shall be established in New York, London, Shanghai, Paris, and Bombay

became

Gold depositories of the Fund shall be established in the United States, United Kingdom, France, and India

and the phrase “at places agreed with the Fund” was added as follows:

“The gold of the Fund shall be held with the depositories designated by the members in whose territories they are located at places agreed with the Fund”.

Reserve Bank of India, Nagpur
Reserve Bank of India, Nagpur

 

IMF gold, anywhere

Since the 1956 Rule E-1 persists into the current Rule F-1 (see Part 1), it opens up the possibility that IMF gold could be stored in any central bank gold vault (or other outsourced vaults) in any of the four jurisdictions of the US, UK, France and India, and even in China in the future if China looked to use its “without prejudice” option to be re-listed in the current day F-1 Rule list.

For example, the wording of Rule F-1 suggests that IMF gold held at the FRB New York vaults could be transferred to another Federal Reserve Bank vault as long as the other Bank had secure storage facilities.

Whether, in terms of Rule F-1, this transferability extends to US Treasury storage locations such as Fort Knox is unclear; the IMF staff document from 1956 seemed to think that US Treasury locations were feasible storage locations since it mentions them as indirect justification for changing the Rule E-1 wording.

There appears to be legal authority for the US Treasury and Federal Reserve Bank to use the Treasury’s Mint institutions for storing foreign central bank gold. Such arrangements were even being discussed as early as the 1940s as the following ‘Treasury Department, Inter Office Communication’ letter from a Mr. Luxford to a Mr. Dietrich makes clear:

“The quantity of gold available in New York for sale to foreign governments for earmarking by the Federal Reserve Bank of New York has declined to such an extent that it will soon be necessary to ship gold from Fort Knox to New York, or make other arrangements for earmarking.

It has been suggested that, to avoid the tying up of transportation facilities and the high cost of shipping, arrangements be made whereby the Federal Reserve Bank can, with the consent of the governments concerned, earmark gold while it is still in the Mint institutions.”

The letter goes on to describe a proposal whereby the FRB could earmark foreign central bank gold in the vault of the Denver branch of the FRB of Kansas City, or even lease private bank vaults in Denver, but if this didn’t solve the space issue, then compartments in Fort Knox and the Denver Mint were available:

“Mr. Howard has contacted the superintendents at the Fort Knox and Denver institutions and I am informed that the following spaces are available:

1. Fort Knox – two compartments which, when filled completely, could hold approximately $1,000,000,000 in gold.

2. Denver – three compartments which, when filled completely, could hold approximately $450,000,000 in gold.”

 Luxford concluded that:

“I believe that there is legal authority for the use of the mint institutions for the purpose outlined above.”

(Source: ‘Treasury Department, Inter Office Communication’, Sept 1943, Clinton Library, gold files)

Fort Knox model

So, there appears to be a legal precedent for foreign central banks, governments and international institutions to hold earmarked gold at US Treasury storage locations. These arrangements would be very useful if the US Treasury needed gold at the FRBNY and, for example, the Treasury conducted a gold location swap with the Bundesbank or IMF, swapping Treasury Fort Knox gold for Bundesbank or IMF gold.

The IMF is legally allowed to engage in location swaps for its gold and has done so numerous times in the past with entities such as the FRB and the BIS. Some of these IMF gold location swaps are covered in Part 3.

According to the current Rule F-1, IMF gold could also be stored, for example, in Bank of England provincial branch office vaults (assuming there are any of these vaults still operational). The Bank of England has in the past stored HM Treasury and other customer gold in its branch offices, for example in Liverpool, Birmingham and Southampton. Some of these branch offices have now closed but the Bank of England still maintains various agency offices across the UK.

In theory it’s possible that IMF gold could be transferred from the Bank of England’s London vaults to secure storage at one of the Bank’s provincial locations or even to emergency storage locations in England or Wales that have, at various times in the past, been considered by HM Treasury and the Ministry of Defence.

The IMF’s Article XIII, Section 2(b) also seems to open up the possibility that the IMF’s gold could be stored in other locations entirely, even in other countries. Remember that Article XIII, Section 2(b) states:

“(b) The Fund may hold other assets, including gold, in the depositories designated by the five members having the largest quotas and in such other designated depositories as the Fund may select”.

The IMF’s Articles will always have precedence over its Rules and Regulations, due to Rule A-1 which states

“A-1: These Rules and Regulations supplement the Articles of Agreement and the By-Laws adopted by the Board of Governors. They are not intended to replace any provision of either the Articles or the By-Laws.”

There is another clause in Article XIII, section 2(b) referring to an emergency, which is pretty self-explanatory:

“In an emergency the Executive Board may transfer all or any part of the Fund’s gold holdings to any place where they can be adequately protected.

There is therefore plenty of legal scope for the IMF’s gold to be stored in locations that at first glance might not appear obvious.

 

Shanghai Surprise

The IMF Executive Board confirmed the five gold depositories of the Fund in November 1946, including the Central Bank of China, Shanghai. However, no IMF gold was ever held in Shanghai because no IMF member country (including China) ever deposited gold to the IMF at Shanghai.

The removal of the reference to Shanghai as an IMF gold depository during the 1956 amendment had its origins in 1949. In 1949 the IMF Executive Board discussed a proposal that Shanghai should be temporarily removed from the gold depositories list due to political instability in the country at that time.

The following Executive Board minutes illustrate the discussion of the proposal that was recommended by the Board Chairman Camille Gutt. The discussion involved Frank Southard (F A Southard), the US Executive Director to the Fund, who had helped plan the Bretton Woods conference in 1944, and Y C Koo, who was subsequently Treasurer of the IMF, and who was part of the nationalist Chinese delegation that attended Bretton Woods:

Gold Depository

The Executive Board considered a recommendation by the Chairman that, in view of recent developments in China, the Fund should remove Shanghai from the list of gold depositories for the time being.”

“Mr. Southard said he assumed the action would be of a temporary character. Mr. Koo said his Government had no objection on the understanding that the action was temporary. However, the Government would wish to reserve the right to raise the matter again with the Fund at an opportune time.

The decision was: In view of recent developments in China and under the emergency provisions of Article XIII, Section 2(b), Shanghai is for the time being removed from the list of depositories in which the Fund may hold assets, including gold. Members shall be so informed. It is understood that China may, at an opportune time, raise the matter again.”

(Source: Executive Board Meeting 465, 21st July 1949)

Central Bank Of China 1940s gold unit

While the decision to temporarily remove Shanghai as a gold depository had been taken in 1949, it re-emerged as an issue in 1956 when the amendment to Rule E-1 was being discussed at a meeting. This was because the Executive Board wanted to ensure that the changed wording to Rule E-1 did not prejudice the previous decision to temporarily remove Shanghai as a gold depository.

The Acting Chairman in the 1956 meeting was H. Merle Cochran, deputy Managing Director of the Fund. The Executive Director for China (representing the Taiwan based government) was Mr Tann:

The Acting Chairman stated that, in order to make it clear that the proposed action would not prejudice a previous decision temporarily removing Shanghai from the list of depositories, the staff wished to recommend the addition of the following paragraph to the decision proposed:

(c) The amendment of Rule E-1 as set forth in paragraph (a) above is without prejudice to the decision of the Executive Board at Meeting 465 (July 21, 1949)”

“Mr. Tann said he had no objection to the staff’s proposals and particularly welcomed the additional paragraph put forward by the management since it would leave no doubt that the 1949 decision was not being nullified.”

(Source:Executive Board Meeting 56, 29th November 1956)

The 1956 amendment to Rule E-1 was adopted by the IMF Executive Board on 9th January 1957, and then reviewed and accepted by the Fund’s Board of Governors at the 12th IMF annual meeting 1957 where Per Jacobsson, Managing Director and Chairman of the Executive Board highlighted to the Governors that

“On November 29, 1956, Rule E-1 was amended to provide for greater flexibility in the location of the Fund’s gold held with designated depositories.”

(Source: Draft letter by Per Jacobsson to the Chairman of the Board of Governors, twelfth Annual Meeting of the IMF)

On paper, the reinstatement of China as a gold depository of the IMF looks possible, but in reality would be complicated by a number of issues, not least the unravelling of claims and representations that could arise from Taipei and Beijing over the 1949 agreement with the IMF.

With Shanghai now re-emerging as a dominant player in the global gold market, its fitting that the story of the IMF’s Shanghai depository should not be forgotten even though it never really existed.

The Nagpur gold vault, which does exist, is itself a relatively forgotten IMF outpost.  But it still contains, or is said to contain, both IMF and Reserve Bank of India gold. For this reason, the Nagpur gold vault, and some of its details, will be the subject of a future post.