Regulation is increasingly forcing banks away from pricing benchmarks such as GOFO, which could collapse should it lose one more member.
With International Organisation of Securities Commissions (IOSCO) regulation playing an increasing central role in the setting of benchmarks, those banks involved are becoming increasingly frustrated with the red tape that surrounds the process.
“Banks are wary of increased scrutiny and regulatory oversight of their management of various pricing benchmarks after the LIBOR rigging scandal and other price fixing findings,” Goldcore founder Mark O’Byrne said.
Following Société Générale’s exit from the GOFO rate-setting process last month, the membership now sits at its minimum possible level of six members, according to London Bullion Market Association (LBMA) rules. SocGen has declined to comment on its exit from GOFO.
“It is all part of a wider trend, with the bullion markets becoming increasingly opaque at various levels. Whether it is Indian gold smuggling data, [unreported] Chinese gold purchases… or even the lack of transparency over the fixing processes and the data itself,” Ross Norman of Sharps Pixley said. “GOFO is all part of the same story.”
“As the banks depart from commodities, the market is shifting into the realm of the non-banking sector, which is notorious for lack of exposure and clarity,” he added.
As well as SocGen, Deutsche Bank announced its departure from the rate-setting process in April this year – as well as from the gold and silver fixes.
“There is reluctance on the part of banks to take part in rate settings due to the regulatory risk and the risks of compliance,” a gold trader said. “The LBMA only recently added some GOFO compliance documents to its website so they are conscious of regulatory scrutiny.”
Should GOFO cease to exist, the market could wind the clock back 20 years to when brokers were able to manipulate the rate at which customers could borrow gold – the reason the benchmark was created in the first place.
“The loss of the longer-dated forward curve data is apparently a loss for the market but, if GOFO goes, how will lease rates be calculated? If another bank exits from GOFO contribution then they either have to change the six[-member] rule or change the process,” the trader added.
The six LBMA Forward Market Makers who now contribute to GOFO are the Bank of Nova Scotia-Scotia Mocatta, Barclays Bank, HSBC Bank, Goldman Sachs, JP Morgan Chase Bank and UBS AG. The GOFO rate represents the rate at which they are prepared to lend gold at on a swap against US dollars, ranging from a one-month rate to an annual rate.
The rates provide a benchmark dataset used as the basis for some finance and loan agreements as well as for the settlement of gold interest rate swaps.
“The irony to all this is that much of what is occurring compliance-wise was in the name of tighter regulation – and the result has been less transparency at various levels,” Norman added.
“It’s a case of be careful what you wish for – it was after all the shadow banking sector that was responsible for most of the instruments that caused today’s economic problems… but the conventional banking sector continues to pay the price,” he said.
With benchmarking regulation now being handled by IOSCO, there is increased pressure on the LBMA to ensure that the rate-setting process is transparently above board in light of the Libor scandal.
Several banks were fined heavily in 2012 for their role in rigging the Libor rate, the administration of which was stripped from the British Bankers’ Association and passed earlier this year to the Intercontinental Exchange – self-regulation was deemed a failure, leading to greater scrutiny of all pricing benchmarks.
Still, market participants have already been querying the significance of the rate in the modern market.
“Some say that GOFO rates were not realistic to begin with meaning either that they don’t reflect the market or that they are not really used,” the trader said.
It has value in its ability to highlight the extent of physical demand in the market and, ideally, should act as early warning of potential stresses in the physical market, Goldcore’s O’Byrne said.
“[But] it is of less importance to the market today than before and, with Deutsche Bank and SocGen having already left the market, it is becoming even less so,” he said. “This may be a sign of things to come and there is the possibility that GOFO is scrapped as it was with silver.”
The rate is essentially the equivalent of LIBOR for the gold market and is used as a benchmark for dealers, central banks and others to swap gold for US dollars with miners who may need gold to meet contracts or investors for short-selling and other purposes.
(Editing by Mark Shaw)