If you were designing a price discovery mechanism which would be used as the reference for trillions of dollars (or pounds, or euros) of financial contracts, I don’t think you would choose something which involved a neutral publication or news service relying on participants in the market to report what levels they had been trading at during the relevant pricing period. It would be far too open to error, as those involved might suspect that it could be possible to influence the level – without falsifying numbers, let me say, but just by, for example, making selective submissions. And to be fair, I don’t believe LIBOR was ever intended to have the significance it has assumed. It was originally a fairly arcane insiders’ rate which only became important to the rest of us as the gap between base rate and reality became wider and wider. The market had to find an alternative, and LIBOR was the obvious way to go. Now, with it splashed all over the newspapers, fines levied on institutions and individuals and the Damocles sword of custodial sentences hanging in the wind, perhaps it doesn’t seem such a good idea to rely on a number so arbitrarily derived.
Why bring up LIBOR again now? It’s not new news. Well, no, it’s not; but neither is its formula unique, and therein I think lies the issue. We already know that various governmental regulatory authorities on both sides of the Atlantic are looking at the same phenomenon in the oil market, although as far as I am aware they seem to have turned up nothing untoward (although if recent reports are accurate, that may be changing). But it can’t be long before there is pressure to look at pricing methodology in metals – particularly given the raised public profile already created by the arguments over financing and warehousing. The straightforward LME price, of course, is pretty much unimpeachable in this, because just pointing to the open-outcry ring where reference prices are created should be sufficient to illustrate a transparent, open price-discovery mechanism. No, the fingers are far more likely to be pointed at, for example, minor metals, where pricing on a publication’s assessment of levels is broadly the norm. Those publications are scrupulous in collating and assessing what they are given, but it’s not on them that the eyes of the investigators will be focused. The publications are in the position of being the messenger, and we all know there’s no point in shooting him.
Shining a Light on Commodity Markets
What I believe is that as part of the whole process of shining a bright light on the workings of commodity markets – as governments have told us they want to do – this area of price discovery is going to become a significant issue. It’s always been the case that the blurred edges of the business, where futures and physical meet, are the most difficult bit for the outsider to understand (traditionally, of course, that’s also been the most profitable area: look at warehousing, which is part of the same blurred line). Futures, be they LME or Nymex, Comex or whatever, are fairly clear; while they may be subject from time to time to some form of artificial pressure, the setting of the reference price is there for all to see. Where there is just a reliance on prices voluntarily submitted, it’s more difficult to guarantee transparency. That’s the way the regulators are going to look at it.
Is there a Solution?
So, what to do? Well, in some cases, cobalt, for example, there is an alternative. There is an LME contract. Now, before the minor metals trade drowns me out with cries that there’s not sufficient liquidity in that market and that the price is probably less representative than the publications’ quotes, I know that. It’s a question of playing the game of realpolitik, and understanding that while the solution is by no means perfect, it’s nevertheless the one which is going to appeal to those in power. I don’t pretend to have a complete solution, but don’t fool yourself; the pricing of physical commodities – except where a market is seen to be so small or so strategically insignificant as not to warrant examination – is only a few ducks down the row, and the regulators’ sights are already moving in that direction. LIBOR was probably the catalyst, but we live increasingly in a world where transparency and audit trails are the regulators’ friends.
There will be Changes
Some traditional price setting methods will change; at the very least, we should expect a much higher level of scrutiny of the way in which prices are reported to the assessors. Remember the middle stage of Ronald Reagan’s comment: “If it keeps moving, regulate it.”