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18 June 2014

Electronic Fix? Would That Make Sense?



Over the last few weeks, I’ve looked at the rumblings in the bullion market about the forthcoming end of the silver fix and what appears to be an attempt to demonise the gold one over the ability of participants to trade their own positions. I suggested that it would be very surprising if the LME were not to consider offering its services as a price-setting mechanism, first for silver and then - assuming my somewhat pessimistic expectations for gold turn out to be correct - for that too. Well, it seems that in fact there are now something like ten operations looking at putting themselves forward to run the silver fix, indeed including the LME, as well as, amongst others, Nymex, ETF Securities, ThomsonReuters and Platts.

Now, it’s important to bear in mind that the cases of the two - silver and gold - are slightly different. The silver fix is definitely gone, as from August of this year, as its membership has dwindled to two, making a legitimate fix difficult to justify. With four members, the gold fix is not in the same straits, but has come under fairly sustained attack over its modus operandi. So while there has to be a change in one, theoretically the other could continue as it is; sadly, though, I expect the sniping will continue.

Electronic Platform Favoured

What is striking about those proposals to replace the silver fix of which I have seen details, is that the majority of them seem to take it almost as a given that any solution will take an electronic form; that style seems also to find popularity amongst the market users polled by the LBMA. In some ways that’s not surprising - electronic markets are undoubtedly the flavour of the day. There are reasons for that; users like the ability to trade directly with the market, regulators like the way a solid audit trail of trades is created. Also, and I suspect that this one strikes a particular chord at the moment, it’s a visible way of taking influence  and therefore, possibly, the opportunity to ‘direct’ the price from the large banks who traditionally dominate the business.

That’s all very good, and it’s quite an attractive package: give the power directly to market participants, put everything openly on-line and keep the evil price ‘fixers’ out of the ‘fix’.

But It's Not Clear-Cut

Except that it’s not that clear cut, is it? Elsewhere on this site, you will find an article reviewing and discussing Michael Lewis’ latest book, ‘Flash Boys’ (16th April - 'Flash Boys' - Are You Being Ripped Off? ). That book kind of changes the view of electronic markets being necessarily the most open and straightforward, with its expose of how technology can be used to tilt the playing field to favour one group of market participants over the others. Now, Lewis is talking about the US stock market, but it would be naive not to accept that the same players have an equal interest in bullion markets, particularly if they are open to the same style of manipulation. He also exposes the myth that volume and liquidity are necessarily the same thing; whatever the volume, if it’s not fully accessible to all participants, it does not equal market liquidity.

LME Sitting on the Fence?

So actually, despite the surface appeal of an electronic fixing process, perhaps the decision is not so obvious after all. It’s interesting that the LME is rather sitting on the fence on this one. They have commented that they are prepared to look at an electronic system based on Select, but that they also have the facility to use the Ring set-up or indeed to continue something similar to the existing telephone fix. Now, one could read that in a number of ways: perhaps they genuinely believe open outcry is better, or perhaps they see the opportunity to use silver as a way of testing the water, and if an electronic solution works, then that could be the death-knell for the Ring altogether. What is pretty obvious is that before submitting a firm proposal, they will have to make their decision on which way to go.  I have to admit to not being neutral in this. Electronic trading platforms have great advantages for the user - LME Select has been a highly successful resource for the business since its inception. However, the activities of high-frequency algo-traders are discernible there, just as they are described in Lewis’ book. They are annoying, but you can work around them, mostly, in day-to-day trading.

Think Very Hard

But if the reference price were to become subject to that kind of problem, though, it would be a genuine issue. And anyway, let’s not forget that the CFTC spent a long time investigating the silver fix for impropriety, and reported no findings of any wrong-doing. Equally, as I said in my previous piece, the accusations of ‘price-rigging’ against Barclays in the gold fix do not appear to stand up to real scrutiny - at least, not if those doing the scrutinising understand how markets work. So it isn’t an open and shut case that the current way of setting the reference price is necessarily inadequate. What is needed to set an honest reference price is openness and transparency; my opinion in this is irrelevant, but I would urge those whose views are of genuine import to think very hard before jumping on to the electronic bandwagon. It is by no means clear that that route is the highway to the sunny uplands of transparent, open price discovery; there are clouds obscuring clear sight there as well.


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