The Manipulative London Fixings: Gold

by: Kurt Dew


Is it fair to characterize the London OTC fixings as inherently manipulative?

This article asks and answers this question for the London gold fixing.

If assuring that the value of assets held by dealers is greater than the value of those same assets held by customers, the London gold fixing is manipulative.

That the ICE benchmark administration, tasked with taming the various fixings, is aware of this daily gold fixing “adjustment,” is discouraging.

Ask me no questions, and I'll tell you no lies.

-- Lynyrd Sknyrd

I recently wrote an instablog published in SA, here, considering the over- the-counter (OTC) market data providers, particularly two firms, the Depository Trust and Clearing Corporation (OTC:DTCC) and Markit - firms that the Dealer Banks own or control - that sell data to OTC market participants at a profit.

The point of that article was this. Far from facilitating the use of market data, these data providers block the availability of information to investors. If the OTC market regulator, The Bank of England, was doing its job, which includes facilitating transparency in OTC markets, the Bank of England would collect that information itself; for example, by requiring traders to copy them on trade confirmations. These same regulators could then make this data available freely to analysts and market participants. This seems fair, since market participants are the creators of the data in the first place. That is, the data is originally the property of traders. Give them back their data. The data providers only retard this process.

The data providers were stood up following the public outrage over manipulation of the London fixing of LIBOR. Thus, in explaining how this odd market practice - providing the public with data that already belongs to the public - happened, it is necessary to address the question, "Why are London price fixings necessary?"

This article and the articles to follow argue that the fixings are demonstrably unnecessary. The dealers want them, and the Bank of England permits it. The history of the fixings is recounted in the Instablog. Here we begin to explain the disastrous effects of these London fixings and detail why the fixings are both unnecessary and undesirable. A complete explanation of the effects of the fixings requires multiple articles. But in this first article, we explain the gold fixing and its effects. Why it's manipulative and why it is demonstrably unnecessary. A proven alternative exists.

Understanding the fixings.

In reading comments before and after the market data instablog's publication, I realized that otherwise knowledgeable financial professionals were unaware of the ubiquity of legal actions from regulators and others against the dealer banks for manipulation of the many London OTC price fixings.

Most investment professionals know of the LIBOR fixings scandal. But even with the LIBOR fixing, it appears that some well-informed readers are unaware of the millions of investments and hundreds of trillions in assets that were mis-priced because of the manipulation of fixings. If you have a mortgage in the United States, for example, your mortgage rate, if based on LIBOR, has been manipulated in the past, according to lawsuits brought by market regulators that the dealer banks have paid billions to settle out of court. Ten men, so far, have gone to jail for manipulating your LIBOR-based mortgage rate.

That any student of financial markets should be in doubt about the purpose, ubiquity, and manipulative effect of the London fixings is a more important issue than the existence of the parasitic data providers. Hence the Instablog inspired this and the following articles, explaining the London fixings and their effect in greater detail. For a brief chronology of the birth of the London fixings, which began with the humble London gold fixing, see the Instablog.

The point of the broader story of the fixings is this. The London fixings are easily the single most corrupting market practice in finance. We will never rid financial markets of corruption. Corrupt individuals find finance a more attractive profession than the priesthood. So, finance will always have corrupt participants. However, we can rid the markets of practices that promote corrupt behavior through their design. Getting rid of the fixings would be a start.

And we suggest that the ICE Benchmark Administration (IBA), a division of the Intercontinental Exchange (NYSE:ICE), which is in place to tame the fixings, is a band-aid applied to open heart surgery. Fixing the fixings is unnecessary, because the fixings themselves are undesirable. Publicly available market prices would enable creation of successful exchanges; and the fixings could be eliminated painlessly in the large liquid markets where they do so much damage.

Who are the dealers that provide us with fixings? The population varies slightly from one market to the next. The most prominent OTC dealers are ubiquitous participants in each of the fixings: Bank of America (NYSE:BAC), Citigroup (NYSE:C), Goldman Sachs (NYSE:GS), and JP Morgan Chase (NYSE:JPM); which jointly trade 89% of the total OTC volume of American bank derivatives as of the third quarter of 2016, according to the Office of the Comptroller of the Currency (NASDAQ:OCC) derivatives report.

What are the London fixings?

As you read the descriptions of the fixings, ask yourself some questions. First, who benefits from the fixings? Second, in the world's largest markets by volume, why is it impossible to provide the public with a market price instead? Except for the gold fixing, begun in 1919, none of these markets was "fixed" before the 1980's. Once upon a time, these markets were all market priced. So, "It's always been done that way," is not a reason for the fixings.

The London fixings are daily communications between a relatively few major market dealers - less than two dozen in every major market where fixings take place - to decide the prices of OTC assets and derivatives; and incidentally related prices such as mortgages. The IBA has been chosen to police this market. I will consider their success in policing the gold fixing first.

The scope of the fixings is broad: including currency prices, wholesale deposit rates, energy prices, and metals prices. There are also London fixings for interest rate swaps. I will begin here with the gold fixing, and follow with the LIBOR fixing. I will then summarize the dozens of suits brought against the dealers for manipulation of a multitude of these fixings.

The LIBOR fixing has been the focus of the greatest attention, but the gold fixing is the first topic, because it was the model upon which the process of "fixing" prices in London began. See my Instablog for chronology of the post-1980 implementation of fixing in most OTC markets based in London. A fourth article will describe the culmination of the history of fixings in a seemingly unending series of lawsuits in each of these major "fixed" markets - each lawsuit resulting in a cash settlement by the major dealers who determine each fixing.

The gold fixing. To analyze the gold fixing, read releases of the IBA, the newly appointed "overseer" of the fixings, and use common sense. First, we will look at releases of the IBA. Then we consider common sense. Finally, we supply the lawsuits alleging gold price manipulation by the gold dealers that have been settled to date.

Here is the IBA's recent proposal to the London Bullion Marketing Association (LBMA), whose members produce the fixing. The IBA proposes that the fixing should become an algorithm. The LBMA quickly agreed. (Nagging common sense question: Is the introduction of an algorithm intended to create the illusion of an un-manipulated price or does it really reduce or eliminate the potential for manipulation?)

Isn't "an auction" an algorithm? This question matters because auctions have been the means of determining the gold fixing since 1919. (Definition of algorithm: a process or set of rules to be followed in calculations or other problem-solving operations.) If the fixing wasn't already an algorithm, what was it? I can't think of a way of producing a daily fixing number that isn't an algorithm. (Nagging suspicion: Algorithm is a highfalutin word that makes the fixing methodology sound less manipulative.)

Here is the IBA's description of the fixing. Please note the minimum number of participants. Three. Elsewhere IBA informs us that when IBA can't find three bidders, IBA releases a fixing anyhow, at the "opening quote." "Use the opening quote," is also an algorithm, I'm pretty sure.

Here is the IBA's English language description of the fixing.

Until IBA became the administrator for the LBMA Gold Price, the benchmark price of gold was determined through an auction in the form of a conference call between the participants that comprised the London Gold Fixing Company. IBA has replaced that conference call with an electronic, tradeable auction process with aggregated bids and offers published in real-time.

In other words, the bids and offers of the participants (between three and thirteen LBMA members) that constitute the auction are now published. But aside from the highfalutin language, nothing else is different, as far as I can tell. (Always remembering that the telephone is an electronic device that operates in real-time, and that three guys can combine their bids and offers with an electronic hand calculator, in real-time. Would further electronics and more "real-time" really matter for a maximum of thirteen people?)

Nagging common sense question: Why is the gold fixing necessary? There is a liquid gold futures market traded by CME Group (NASDAQ:CME) that is settled without reference to the London gold fixing. Why not hold a continuous "auction" of all parties to spot gold transactions that can produce sufficient trading margin? We would call that a spot gold exchange. It would produce impersonal, harder-to-manipulate market prices.

If you think that a market price set by between 3 and 13 people, albeit in a highly electronic way, might just be manipulated, you may be interested in knowing about the "seller's premium." The seller's premium is the $0.15/ounce premium, added to the published gold fixing, at which the dealers participating in the gold fixing value their holdings of gold each day. IBA describes it here. How is that not manipulation? But you've got to like the direct approach to manipulation.

Settled lawsuits in gold price manipulation: According to Bloomberg, Deutsche Bank has agreed to settle its share of a suit alleging manipulation of gold prices by Deutsche Bank (NYSE:DB), HSBC Holdings Plc (NYSE:HSBC), Bank of Nova Scotia (NYSE:BNS), UBS AG (NYSE:UBS), Barclays Plc (NYSE:BCS) and Societe Generale SA (OTCPK:SCGLY). Deutsche bank agreed to "turn over instant messages and other communications to help further [the litigant's] case" as part of the agreement. In comparison to settlements in the LIBOR fixing suits, the gold settlement is miniscule, perhaps in part because the gold market itself is miniscule in significance, in comparison to LIBOR.

The next article will detail the gaudier corruption of the LIBOR fixing. Then I will continue with the procedures for fixing, and the settled lawsuits concerning the London currency fixings, and the London interest rate swap fixings. Incidentally, other countries, notably Australia, have adopted their own versions of the London fixings. And lo and behold, have subsequently experienced a fixing scandal all their own.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.