Rigging a Price…or Defending a Position?
I think today I’m going to stick my head in the lion’s mouth and talk about the gold fix and the recent ‘scandal’ perpetrated by Barclays and its gold traders. And having confessed to a certain amount of sympathy for Deutsche a couple of weeks ago, I’m going to have to say the same for Barclays – quite a strange feeling, really.
I’m not going to rehash again the need for reference prices in commodity and financial markets; I know the popular press doesn’t seem to grasp (or at least, finds it can sell copies by seeming not to grasp) why that should be so, but I think I can assume that knowledge in the readers on here.
The Gold Fix
So, what happens in the gold fix? Well, twice a day, four banks (used to be five, until Deutsche dropped out) get together on a conference call (no more meeting at Rothschild) to set the reference price for London good delivery gold. I’ve worked at two of the fixing banks (or they were then: they’re not any more) and in my experience of that, the procedure is pretty simple. One person – normally the senior dealer – is on the fixing call and his (or her) colleagues have their customers following proceedings live via the telephone, Reuters, Bloomberg, MSN or whatever. Those customers are free at any point to put in, change or cancel orders to be executed. The dealer running his bank’s book then nets off all his customer input and feeds that total into the fix. When what the four of them want to do balances (within 50 bars) the price is ‘fixed’. I repeat, anyone can change their order at any time until the fix is made. Pretty transparent, I would have thought.
Now, the wrinkle that Barclays appear to have been caught by is of course the issue of proprietary trading, because added in to the process I have described is that the banks themselves are free to trade their own position. In other words, they are acting, during the fix, in dual capacity – broker for their customers’ orders and trader of their own position. There is a tension in that relationship, but the negative aspect of that tension is pretty much outweighed by the improved liquidity that it provides.
The accusation against Barclays was they they allowed their trader effectively to trade against customer orders, it is suggested to the detriment of the customer. I don’t quite see how that stacks up. It appears that the customer had bought a call option ( I believe it was a digital, which has implications for the payout, but not the principle) and approaching expiry the price was hovering around the strike. So, the payout was to be determined by the fix in question, and, pretty obviously, the two parties to the contract – the bank and the customer – had different desired outcomes. One wanted the price up, to get the option declared and the payment made, the other wanted it down, so the option expired worthless. Despite the way this incident has been reported by some of the press, it would be naive to assume that that was it, and both parties just sat on their hands and waited to see what happened. This deal was part of a trading book, and surely it’s accepted as normal trading practice if traders increase or decrease their position with a view to making a profit or minimising a loss – let’s say to improve or defend their position?
So I don’t really understand what was the problem; the customer – presumably a fund of some description – complained about the behaviour of its counterparty (the bank) and the bank, presumably rolling its eyes, seems to have decided that the best solution in current circumstances, was to hold its hands up and take the punishment for – what, exactly?
What Next in the Cross-Hairs?
I’ve dwelt on a specific incident at some length here, and I would be very grateful for comments from readers who see it differently from me, but there is actually a wider point, one that I and many others have mentioned before. In the wake of the havoc caused by sub-prime, by CDOs, and CDO squareds and a plethora of other acronyms and after the revelation of the unreliable nature of LIBOR, the world at large and regulators in particular seem convinced that all banks in all financial markets are always doing something wrong. Any trader will obviously understand the difference between LIBOR and the precious metal fixes – one is a ring-round by a news service to establish where players suggest they think they might be able to trade if they needed to (and thus pretty clearly open to suspect numbers being given) and the other is a live market where players are liable contractually to fulfil any trades they make (so if you want to start playing games, you’d better have deep pockets).
The silver fix will soon be history; my guess is that gold will be forced to follow it. After that, what next? Platinum and palladium, presumably. LME second-ring closes? Who knows where the cross-hair will settle next? What concerns me is that in the rush to find problems, real issues – such as the need these markets have for reference prices – are simply being pushed to one side. Honestly, it’s not clever to sweep something away without knowing how to replace it. Yes, the death of silver and possible death of gold may create opportunities for the LME, for example, if it can protect itself, but wouldn’t it be better to think about how to construct the new before dispensing unilaterally with the old, which is, I fear, not what is happening at the moment?
Changing the Status Quo…….
On a totally different scale, apparently invading Iraq seemed like a good idea at the time, with no need to think of what might replace the status quo; there’d be plenty of time to sort that out later. Mmmm, that went well.