Existing opportunities
Existing structure
Lessons from other asset classes
Leveraging technology
Introduction
Precious Metals Market Post-Trade Spotlight Review
Opportunities in the existing post-trade process continued
The clearing and settlement of Loco London precious metals trades is concentrated in a limited number of LPMCL members There is limited membership of LPMCL, and there is potential for a disruptive effect if one of the four existing members were unable to continue offering clearing or settlement services either on a temporary or permanent basis. LPMCL is open to new member firms who are looking to offer clearing services to other market participants in the precious metals market. However, there are pre-requisites for becoming a member including, for example: (i) maintaining confidential secure vaulting facilities within central London locations, using either their own premises, or those of a secure storage agent; and (ii) becoming a signatory to a code of practice on clearing under which members undertake to operate unallocated precious metal accounts between themselves.
Loco Zurich could benefit from implementing a similar infrastructure to LPMCL, and extending the LPMCL model to the Zurich market could enhance the efficiency of the European precious metals market, reducing concentration risks associated with precious metals clearing, and leveraging the benefits of standardising and scaling technologies. The settlement period for precious metals could be shortened, in line with efforts for other asset classes Longer settlement periods increase exposure to the risk of default 7 and broker-to-broker counterparty risk 8 . This requires more margin to be posted, impacting market liquidity. The precious metals market may see similar benefits to the equities market when the settlement period was shortened from T+3 to T+2 in 2014 9 , which are likely to increase when the industry-led push for T+1 settlement is implemented, all of which benefit the end- investors. In particular, a shorter settlement period: increases liquidity; reduces the time-horizon for risk exposure; and promotes better use of capital by reducing margin requirements.
Unlike equities markets which are largely on exchange, the unallocated precious metals markets in London and Zurich operate on an OTC basis. This means that in theory, the counterparties to each bilateral trade can determine the settlement date themselves, and this can be the same day as the transaction if there is time remaining in the day to process both the currency and metal settlement obligations. However, to aid price transparency and standardisation, the market trades off a standard settlement date, the price for which is commonly referred to as the “spot price”. In the precious metals market, the spot price is for a settlement period of T+2. Shortening the settlement period on spot contracts will impact other parts of the precious metals market ecosystem (for example, margin investing systems would require re-engineering), meaning that consensus is required from a wider audience. Further, the benefits of shortening the spot settlement period must be balanced against the risks:
The current spot settlement period is a function of the time required to clear and settle trades, using the prevailing technology and customs at the time the conventions were established. However, many trades do not go through sophisticated trade processing systems. This could mean that a reduction in the spot settlement period, which leaves less time to match trades, would potentially increase trade failures. Due to the time differences in settling the metals and currency leg, there is increasing difficulty in agreeing and matching trades as the trading day progresses and the shortening of the timeframe where both markets remain open. There is a risk that a reduced settlement period impairs the resilience of market clearing and settlement, as a shortened settlement period does not allow for an appropriate recovery time should system interruptions take place. High market volatility could cause difficulties for shorter settlement.
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