British Regulatory Watchdog Reviews Gold Fixing Process

Since it was revealed last June that the British banking giant Barclays (NYSE:BCS) manipulated LIBOR rates during the economic downturn of 2008 (see Barclays Paying $451 Million in LIBOR-Fixing Case, Who’s Next?), financial regulators around the globe have launched a series of investigations into the manner in which several benchmark rates are calculated. With some global banking giants settling this issue with regulators since, and quite a few still being investigated, there have also been various changes implemented to the process of determining benchmark rates to ensure they are more transparent. Clearly, the motive here is to ensure that a handful of organizations contributing towards the calculation of a benchmark rate do not make undue profits from the inherent information asymmetry in the system.

And it is this very thought that brought the London gold fixing process under the U.K. Financial Conduct Authority’s scanner. ^[1] The $20 trillion global gold market is not a small one, and the five members of The London Gold Market Fixing Ltd who are responsible for fixing gold prices twice a day are all global banking giants with sizable commodities trading businesses. Barclays is one of the five members, with the others being Deutsche Bank (NYSE:DB), Bank of Nova Scotia (NYSE:BNS), HSBC (NYSE:HBC) and Societe Generale. Quite notably, Deutsche Bank and HSBC are currently under investigation by several financial regulators over rate-rigging charges.

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The London gold fix prices are used as the standard benchmark for valuing gold products and derivatives around the world, because of which it is imperative that the manner in which these prices are determined be as transparent as possible. The current fixing process has been in place for almost a hundred years now, with the five members coming up with the benchmark price over a telephonic conference that often goes on for more than an hour. ^[1] As the people involved in the process are free to continue trading over the duration of the conference, they can potentially use the information they have access to before the price is actually made available to the public at large.

While that in itself seems like a flaw, what makes things worse is that both Barclays and Deutsche Bank frequently figure in the list of top 5 investment banks in terms of market share in the commodities market. Additionally, HSBC and Societe Generale also have a considerably large commodities trading desk. So there is a conflict of interests here for the banks involved.

So what can we expect from the reported review of the gold fixing process by the FSA? If the review does show irregularities in the way the gold price is fixed, or indicates that the banks involved can game the process to book considerable profits at the expense of others who are not privy to the information, then the process will likely be revamped in the coming months to plug the holes.

As for the banks, any sign of wrongdoing could attract penalties running into the billions. And a stricter process could also cause FICC trading revenues at these banks to dip. The impact of a reduction in FICC trading yields on Deutsche Bank’s share value can be understood by making changes to the chart below.

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1. Gold Fix Drawing Scrutiny Amid Knowledge Tied to Eruption, Bloomberg, Nov 25 2013 [↩] [↩]