Bringing Transparency and Scale to the Bullion Investment Market
Thu, 10 Apr 2014 07:50:00 GMT
In this article, Mike O’Hara – in conversation with Seamus Donoghue, CEO of Allocated Bullion Solutions and Peter Fredriksson, CEO of Baymarkets – looks at how the introduction of a new centralized trading platform in Singapore is bringing about greater transparency to the physical gold market in the region.
With the benchmark price for the world’s gold products set by the twice-daily London gold fixing and with the LBMA (London Bullion Market Association) operating as the primary association representing the industry, London is generally considered the centre of the world’s physical gold market.
However, it is China that is now the world’s top consumer, producer and importer of the precious metal. In 2013, demand for physical gold in China grew by 32% to 1,066 tonnes, overtaking India for the first time. Traditionally the largest portion of consumer demand for gold in Asia was in the form of jewellery, however since the credit crisis much of the demand for gold has been in investment format, i.e. bars and coins, and that demand has been growing rapidly despite the recent price setback.
Limited Infrastructure and Opaque Pricing
To date, the infrastructure supporting the growing demand for investment in physical gold in Asia however has faced limitations, being predominantly manual rather than electronic. Transactions are typically driven through retail as opposed to private banking and investment channels, with consumers buying through mechanisms that tend to operate on very high margin.
As a bilateral OTC market with no central electronic marketplace, the physical gold market (not only in Asia, but around the world) can be somewhat opaque with little transparency around pricing. Prices are generally quoted as a spread around the Loco London price, a spread that can be very wide and that can vary enormously between delivery locations or “locos”. In India for example, where there are strict border controls and import quotas, the premium over the London fix has been as high as $200 an ounce in recent months.
The Need for a Centralized Electronic Market
Seamus Donoghue, CEO of Singapore-based Allocated Bullion Solutions (ABS), is determined to change the status quo and bring more transparency to the physical gold investment sector by offering centralized electronic trading, post-trade automation, as well as custodial and collateral infrastructure to participants on both the buy-side and sell-side.
“Having transparency around physical premiums will be a game-changer for the gold market because nobody provides that right now, neither on the institutional side nor the private client side”, he says.
“Price discovery is an opaque process, so what we’re doing with our new platform is replicating the model that has worked for Foreign Exchange, for Equities, for Rates, for many other instruments where centralized electronic markets have brought about greater price transparency, resulting in better liquidity. Anybody can provide liquidity in financial products and the case to centralize those products has been very strong and successful. The case to replicate that model for a physical asset where market-makers need to have inventory in the specific location quoted to make a price is even more persuasive from a client perspective. And the two-way liquidity issue is important because physical gold tends to be a somewhat one-sided market, where the bid side can be difficult to ascertain given the lack of custodial infrastructure, chain of custody validation, and the risk of fraud” says Donoghue.
Since launching in March 2013, Donoghue and his colleagues at ABS have spent most of their first year building out the infrastructure from an institutional dealer perspective (there are now six dealers on the platform) and building global arrangements with bank and non-bank custodians. More recently the firm has started pushing the platform out to the private wealth sector where, according to Donoghue, the reception has been good.
“The dealers like this because it allows them to access the investment sector that now accounts for 42% of total demand and is largely uncovered from a distribution perspective given that they trade in kilos rather than the tonnes that their traditional clients trade. And clients in the private banking sector like it, particularly in Singapore and Hong Kong where typically they haven’t built the same kind of infrastructure for gold that you might find in wealth centers like Switzerland. Asian clients buy gold but they are currently purchasing it away from their private banks because although the rapidly growing wealth sector would like to offer it as a product they have a large priority list of other regulatory tasks to clear before they can focus on building new platforms – that regulatory onslaught has becoming overwhelming since 2008 which is the same time that the investment sector for physical gold began to grow rapidly in Asia. We’re enabling them to jump their internal priorities by offering a turnkey solution for accessing everything, from trading to custody to collateralization”, he says.
The technology underpinning ABS’s offering is the EDGE trading platform from Stockholm-based Baymarkets, a technology vendor specializing in hybrid trading systems that facilitate migration between voice-based and electronic trading.
Baymarkets’ CEO Peter Fredriksson has a long history of helping firms that operate in the OTC sector automate their manual trading processes, having introduced the EDGE technology to market operators around the world in the interest rate derivatives, energy and now the precious metals sectors.
“OTC markets globally are coming under pressure from regulators to be more transparent, more standardized and more automated and it’s clear that physical gold trading will follow a similar trajectory”, he says.
“The challenge is how to keep the flexibility of the manual, bilateral OTC market while bringing in the efficiencies of electronic trading through a centralized platform. And the answer lies in taking a hybrid approach, which gives you the best of both worlds”.
Baymarkets’ EDGE trading solution is specifically designed to address challenges such as these, according to Fredriksson.
Opening Up the Market
“One of the challenges of OTC markets is that liquidity is naturally fragmented, with a small number of high value trades. But with this technology, ABS will enable dealers to change the quantum of how they quote, allowing them to trade more frequently for lower volume transactions, all within a scalable platform”, says Fredriksson.
One of the results of opening the market up in this way is that it is likely that to attract new participants such as electronic market makers and arbitrageurs, who might already be very active in the spot gold, futures and ETF markets, or in other correlated asset classes. Are these the participants that ABS is targeting?
“We’re not directly going after high frequency traders”, says Donoghue, “we’re more looking to fulfil the end users. But without a doubt if those guys are going to provide real liquidity to our investment sector clients, we will be happy to work with them”.
Untapped Assets Under Management
With private and central bank holdings of investment gold globally estimated at over $2.5 trillion, and a large percentage of those holdings sitting with individuals in Asia, physical gold is currently a massively untapped source of AUM in the region. And Donoghue believes that this is where the real opportunity is for the private banks and wealth managers.
“There’s a big battle going on right now amongst private banks in Asia for AUM”, he says.
“With gold so widely held in the region, wealth managers are looking for ways to help their clients find an easy solution to source liquidity from their current physical holdings, but it’s difficult to trade physical gold. We’re looking to make it much easier for them, as easy as the paper gold market.
“As for banks, they’re are divesting themselves of commodities but they’re still keeping the trading of precious metals, particularly physical gold because it’s viewed as core banking activity, like FX. So those activities will migrate to the FX infrastructures of the banks. Obviously FX is a very scalable, industrialized model, so we’re looking to help facilitate the banks to integrate physical gold into that model”.
In conclusion, like many of the world’s OTC markets, physical gold is primed for a revolution in market structure and technology. These are challenging – but also exciting - times for participants in the market and it is encouraging to see trailblazers such as ABS and Baymarkets leading the way.