London's Gold Crown Is SlippingBy and
Basel III rules on lenders’ balance sheets may also hit market
Added uncertainty comes from Brexit as banks mull moving desks
London is losing its Midas touch.
New rules from regulators, on top of uncertainties over the U.K.’s future relationship with the European Union, are denting the city’s position as the biggest center for gold trading in the world. The changes threaten to push up costs, a key competitive advantage of London’s over-the-counter market.
Even before the regulations come in, the average net daily volume of gold settled by London Precious Metals Clearing Ltd. fell 12 percent in two months to 18.5 million ounces in August. In New York, the British capital’s biggest rival, trading in gold contracts jumped more than 25 percent in the third quarter from the previous three months, with activity during European hours surging 32 percent.
That’s as traders scratch their heads over how changes to EU rules over reporting of transactions, known as MiFID II, and capital requirements under the so-called Basel III framework will affect their costs in London, where deals are mainly off exchange. That could reduce precious metals liquidity as banks leave the market because of high costs, the London Bullion Market Association said in a note on Sunday.
“MiFID is just a pain, and it’s not the only one,” said David Gornall, a former chairman of the LBMA and founder of DG Metal Consultants LLP in London, which dispenses advice on coping with legislation. “People don’t know what’s expected of them.”
At issue is whether OTC trading of gold, which is backed by metal in a vault but isn’t typically delivered or allocated, should count as derivative trading. If it is, under the revised Markets in Financial Instruments Directive, then traders may face higher costs, eroding the main advantage of trading off-exchange.
That reduces London’s advantage over New York, where gold is traded via derivatives on the Comex exchange, perhaps encouraging some to reconsider where they place deals.
On top of such pressures, the U.K.’s vote to leave the EU has already prompted some banks to consider moving staff from London to other cities in the union.
Cleared trading in London, which makes up only part of total volume, fell below New York’s for the first time in 2016, according to data from research firm CPM Group. Gold futures for December delivery rose 0.2 percent to $1,306.70 an ounce Monday by 9:39 a.m. on the Comex in New York.
“They’re moving business out of London,” George Gero, a managing director at RBC Wealth Management, said by phone. “If you add everything together, there’s been more volatility and more liquidity on Comex,” he said, also citing increases in high-frequency trading, haven demand and hedging record share prices as positive trends for the exchange.
The city’s greatest challenge may come from tightening of rules governing lenders’ balance sheets as set out in the Bank of International Settlements’ Basel III accord, according to DG Metal Consultants’ Gornall. Efforts by the LBMA to lobby for the BIS to recognize gold as a high-quality liquid asset were thwarted by a lack of reliable data on trading volumes.
"Trading gold OTC is going to become more expensive and more challenging for certain participants as a result of Basel," Kate Eged, head of precious metals at the LME, said in an interview in London on Thursday. "Is regulation pushing some volumes onto exchanges? Yes. Do I think this is going to lead to the death of OTC trading, in any asset class not just gold? No, absolutely not." Volume on the LME’s gold contract reached a daily record last week.
The LME and a group of banks have launched gold and silver futures contracts in a bid to make trading in the city more transparent. Bloomberg LP, the parent company of Bloomberg News, provides transparency and transaction reporting for firms complying with MiFID II.
The LBMA is seeking to overhaul the OTC market before new regulations are set to hit early next year. The association and financial technology firm Boat Services Ltd. are launching a trade repository to register volumes, with a total of 13 market making banks. It has also convinced vault operators to publish figures on their holdings.
Still, the prospect of volumes shifting away from London’s off-exchange market has other venues licking their lips, with CME Group Inc.’s Comex in New York hoping to be a key beneficiary.
“There’s lots of confusion with MiFID II and what’s coming out in January 2018,” Young-Jin Chang, global head of metals products at CME Group, said by phone. “Regulation under the CME is a certainty -- the market likes to see certainty.”
— With assistance by Ranjeetha Pakiam, and Silla Brush