FMSB Sees “Golden Opportunity” for Precious Metals Post-Trade Change

The Financial Markets Standards Board (FMSB) has published the latest in its series of spotlight reviews, this time looking at precious metals post-trade processes and highlighting “a golden opportunity to innovate” in the space.

This latest review identifies prevailing structural and technical opportunities for improvement, and considers emerging technologies which could be applied. Whilst much of it refers to the precious metals markets in their entirety, FMSB says some observations will relate only to the unallocated Loco London and Loco Zurich market. Derivatives of precious metals, whilst an important part of the market ecosystem, are traded and cleared like other asset classes and are out of scope of the review, it adds.

The review sees opportunities for increased automation for trade confirmations, something that would solve the issue of a lack of standardisation – specifically many existing systems’ inability to sync with Swift. It also argues there is “insufficient adoption of netting for non-prime brokerage transactions”, adding that increased non-PB netting would increase liquidity in markets and reduce outstanding settlement obligations.

The paper also observes that the limited number of members of the London Precious Metals Clearing (LPMC) utility (there are four) creates dislocation risk if one or more are temporarily or permanently unable to provide services.

As is the case elsewhere, there is a heavy focus on settlement risk in the paper, which argues the existing T+2 settlement period for precious metals should be shortened in line with efforts in other asset classes. The paper acknowledges that Delivery vs Payment (DvP) will be challenging to achieve without significant changes to how the precious metals markets operate. “Where different legs of a trade are transacted together but settled separately, there is a risk of settlement failure if the metal is settled but the corresponding currency payment is never made,” it explains. “Having DvP would reduce the risk of settlement failure as both assets in the trade would be exchanged simultaneously.”

The paper points out that the use of DvP is limited across the precious metals market and would require the ability to process a single synchronised message process across the currency and metal leg. In the current market, there are operational challenges in combining commodity leg and currency leg messages as they are sent through different systems, it explains, adding the settlement infrastructure for metals and the currency leg are also entirely separate. “To change this in isolation, the market would either change the time that metals or the currency leg are settled,” the paper argues.

It further acknowledges lessons and hints that can be taken from elsewhere, notably the existence of CLS in FX markets and the ongoing Project Jura, which is experimenting with central bank digital currencies (CBDC) for cross-border settlement.

The paper also observes the potential for tokenisation in precious metals markets, suggesting, “A digital solution whereby physical assets are tokenised may offer the market lower margin requirements, reduce settlement risk and allow for shortened settlement which could be instantaneous and/or allow atomic settlement, where one leg of a trade is settled if, and only if, the other is also settled.

“T+0 settlement under today’s infrastructure has drawbacks due to the understandable difficulties in trusting that an anonymous market participant can deliver on their side of the trade,” it continues. “Tokenisation, however, would mean that each physical asset has a digital twin, thus allowing an improved infrastructure of less fraudulent activity. This is because all bars traded on the market are registered and traceable on an immutable basis as pledged collateral.”

The paper highlights work by the London Bullion Market Association (LBMA) and the World Gold Council (WGC) to develop and implement an international system of gold bar integrity that will create an immutable record of a gold bar’s place of origin and chain of custody. The blockchain-backed ledger will register and track bars, capturing the provenance and full transaction history. “While the initial focus of this work is not on confirmation and settlement in the unallocated precious metals market, it may provide a pathway to the significant investment that would be required by all market participants to achieve a tokenised digital market,” the paper states. “However, it is also understood that future regulatory change might be necessary to facilitate a large-scale adoption of this technology whilst preserving market integrity.”

“I’m delighted to see the opportunity for the market to make material improvements to the efficiency of its post-trade processes,” says David Tait, CEO of World Gold Council. “This progress could be incremental, or perhaps more radical, and this Spotlight Review gave us an opportunity to look at our toughest issues through many lenses. Of course, we must move at the pace that ensures the marketplace operates in a fair and effective manner, but looking at the ground this review covers, it’s clear that we now have a golden opportunity to innovate.”