FMSB Paper Seeks to Enhance Precious Metals Market Structure

The FICC Markets Standards Board (FMSB) has published its latest Spotlight Review examining the existing structure of the precious metals market. It examines practices adopted in other asset classes and considers how certain features of the spot and forwards precious metals markets could be adapted in order to promote greater transparency, efficiency and participation in these markets.

Developed by the FMSB’s recently-established Precious Metals Working Group, the review identifies a number of ways in which the current precious metals market structure could potentially be enhanced. Specifically, it calls for the increased use of central limit order books (CLOBs) to augment transparency and make liquidity easier to source and quantify. Alongside this it also makes the case for the introduction of central counterparties (CCPs) for clearing and settlement to reduce bilateral credit and settlement risks and potentially drive greater market participation. Finally, the review believes optimisation and compression solutions to reduce capital and margin costs of precious metals trading activity would benefit the industry.

The working group observes that London OTC precious metals markets are sufficiently liquid to support developments in the market structure and that OTC PM markets more generally could benefit from greater choice in how trades are executed, and how credit, capital and settlement are managed.

Overall, it finds that the proposed market structure change would bring about greater transparency and trust in the market, helped by more predictability of behaviours, greater confidence that the rules and oversight are being adhered to, as well as confidence on the part of customers that they are being treated fairly. The use of CLOBs and CCPs also enhances the ability of those charged with market surveillance to monitor behaviour, it also provides easier access to market data.

The biggest hurdle is, unsurprisingly perhaps, cost, with the review suggesting that higher per transaction costs may result. It also acknowledges that a lack of adoption of centralised trading and clearing infrastructure could result from the increased costs. The review adds though, that these costs could be offset if the centralised infrastructure enables capital and margin optimisation. The review further observes that the experience in other FICC asset classes is that costs associated with price discovery and sourcing liquidity are also reduced, however it does warn that risk warehousing could be inhibited by the greater transparency.

The review also outlines a number of transitional steps that could be taken to deliver some of the benefits of the broader infrastructure changes without the corresponding hurdles to full adoption. Namely this includes an open access model, where the CCP is not tied to a CLOB, and pre-agreed settlement and credit terms to allow players to interact directly on the CLOB. The use of PvP is also suggested, as is, as noted, compression and optimisation.

In concluding, the review reiterates that there are “notable long term benefits to the fairness and effectiveness of precious metals markets” supporting the adoption of the proposed changes. Furthermore, it adds, these structural developments could further augment investor trust in precious metals markets and thereby help drive increased market participation.

“London currently accounts for the majority of OTC volumes in gold and silver spot and forwards,” says Myles McGuinness, CEO of FMSB. “Today’s Spotlight Review identifies a number of developments which could further support a fair, transparent and effective spot and forward precious metals markets. Alongside our recently published Transparency Draft of the Standard for the Conduct of Participants in LBMA Precious Metals Auctions, we hope that this Spotlight Review will initiate wider debate about how the structure of these markets could potentially evolve for the benefit of market participants, London as a global centre for the trading of precious metals and the UK economy as a whole.”

David Tait, chair of the FMSB Precious Metals Working Group and CEO of the World Gold Council, adds, “The FMSB Precious Metals Working Group aims to promote increased transparency, trust and understanding in precious metals markets for the benefit of all market stakeholders which may in turn help drive greater participation. The Group believes that London OTC precious metals markets are sufficiently liquid to support developments in market structure and could potentially benefit from greater choice in how trades are executed and how credit, capital and settlement are managed post-trade.

“The Spotlight Review identifies a number of developments to support this, as well as suggesting transitional steps for adoption,” he continues. “I look forward to continuing the important work of the PMWG and engaging with wider market stakeholders to encourage collaboration and progress on taking our ideas forward.”