Wednesday, May 24, 2017

Trading gold - CME vs. LME - This could be an interesting battle


With a new regulatory environment, the traditional gold market is up for grabs.  While many of the changes have not been direct to the gold market but based on a broader environment, regulation is changing the market structure for trading in gold.  Regulations which increase the cost of trading over-the-counter has and will push gold trading onto exchanges, centralized counterparts (CCP's). This environmental change is the opportunity for new exchange entrants in the gold market. We have already seen new trading through ETF's over the last few years change gold dynamics and now there is the opportunity for changes in futures trading.  

For many hedge funds and managed futures traders, the main point of access for trading is the futures exchange. In this case, the COMEX exchange of the CME. However, the LME wants to become a rival through new gold futures contracts. The question becomes whether the move to exchange trading gold around the globe will allow for another exchange to take advantage of the opportunity and co-exist with the CME or take market share. History has shown that there are few cases of successful entry into the futures markets relative to an established marketplace. Regardless of the regulatory environment, it is hard for new exchanges to break the network economies created from a successful trading forum. There has to be something different to attract traders. 

What makes this time different is the changes in regulation that will increase the costs for major banks to trade gold OTC. With higher risk weights, credit valuation adjustments, higher margin requirements for non-CCP trades and for longer margin period of risk (MPOR), exemption of leverage ratios for CCP trades, standardization, and best execution standards all affecting OTC trading, there will be movement to exchanges. The issue is how much, how quickly, and where. The COMEX/CME has served many participants well but is a standardization model different than what has been used by the LME. 

The LME would like to threat the needle and provide something that has the concentrated liquidity of the COMEX and the features well-known to industry LME users. Hence, the "hybrid" approach of LMEprecious will allow for more flexible trading.  With daily dates tradable from T+1 to T+25 and third Wednesday monthly prompts for 24 months and another 12 quarterly dates, the LME contracts will provide more flexibility than the COMEX. The question is whether the cost can be reduced enough to facilitate the switch from the OTC market.   

This will be a battle worth watching. 

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