A regulatory over-reaction to allegations of gold market manipulation could deal a fatal blow to the commodities trading desks of investment banks that are already in retreat.

It has been a difficult few years for fixed-income, currencies and commodities (FICC) trading. In 2009, FICC trading made $142bn for the 10 largest global investment banks, 63% of total revenue. By 2013, that figure had halved to nearly $74bn, accounting for slightly less than half of revenue.

In the very same period that has seen profits dwindle, global regulatory (and in some cases, criminal) investigations into conduct around reference or benchmark rates have caused the legal costs and provisions faced by banks to soar.

Regulatory investigations have affected individuals as well as institutions. A total of 16 individuals have, to date, been charged with criminal offences in the US and UK with respect to Libor. More recently, global enquiries into alleged manipulation of foreign exchange benchmarks have led to at least 30 traders being suspended or fired by their banks.

It now appears the next benchmark – and next part of the trading floor – to face regulatory scrutiny is precious metals trading and, specifically, the London Gold Fixing.

Fix prices

Gold prices are set by representatives of the five market-making members of the London Bullion Market Association. In a twice-daily telephone conference, at 10:30 and 15:00 London time, a panel comprising representatives from Bank of Nova Scotia, Barclays, Deutsche Bank, HSBC and Société Générale seeks to discover the price at which the total volume of sales orders reported by the panel equals the total of buy orders (within 50 bars). The price at which that balance is struck becomes the fix price.

As early as March 2013, the Wall Street Journal reported that the US Commodity Futures Trading Commission was “scrutinising whether prices are being manipulated in the world's largest gold market” as part of an “expanding review of global benchmarks”.

In December 2013, it was reported that Germany’s Federal Financial Supervisory Authority had demanded documents from Deutsche Bank as part of an ongoing investigation into manipulation of gold and silver prices. And in April 2014, Bloomberg reported that the UK Financial Conduct Authority (FCA) was observing the daily conference calls during which the gold price is set.

Alleged manipulation

In addition to enquiries from regulators, the five banks comprising the fixing panel have been named as defendants to a series of lawsuits brought by individual investors and financial institutions. One such claim has been filed in New York by Connecticut-based hedge fund AIS Capital Management.

In common with other plaintiffs, AIS alleges in its lawsuit that it suffered “substantial financial losses” on futures and options contracts – which depend for their price or value on the spot price of gold – on account of the London Gold Fixing panel banks engaging in conduct alleged to include “collusively manipulating the price of gold and gold derivative contracts”.

Alleged techniques also include dealing in gold derivatives during the fix, and “reaping profits from their foreknowledge of price movements in the gold market”. The lawsuit also claims that the panel members engaged in placing or reporting “spoof trades” during the fixing process “that are announced but never intended to be carried out – with the purpose of suggesting a decline in the spot market price, permitting the [panel banks] to enter into large purchases after the fixing”.

All five banks – Deutsche, Nova Scotia, Barclays, Société Générale and HSBC – have issued public denials of the misconduct alleged by AIS Capital and other plaintiffs, and all five deny any wrongdoing.

Regulatory (over)reaction?

The reported regulatory enquiries into gold price fixing are at an early stage. At the time of writing, neither the UK nor US authorities have announced the commencement of formal investigations. So far, regulators appear to be engaging in fact-finding and educational exercises, as opposed to rushing to act where regulatory action may not be warranted. 

The gold – and foreign exchange – investigations come at important crossroads for the regulation of commodities markets. As the UK financial regulator has recently acknowledged, “the FCA regulates commodity derivatives, but not the underlying physical market”.

Whether or not there is a case to answer in respect of the London Gold Fixing, the result of the allegations that have arisen over the past year, appears clear. The European Commission has recently proposed a new regulation on benchmarks, and launched a consultation on the extent to which spot foreign exchange contracts may be deemed “financial instruments” for the purposes of regulation. More regulation seems inevitable, even if the outcome of certain enquiries does not.

Scaling back

In April, Deutsche Bank withdrew from the London Gold Fixing panel, and is among several banks that have scaled back their commodities business in recent months. It is not fanciful to suggest that the retreat from commodities trading may, in part, be attributable to the spectre of increased regulation, and the possibility of expensive and long-running investigations, resulting in fines similar to those imposed in respect of Libor.

There can be no doubt that the standards of transparency expected of financial markets have changed markedly since 2009 and Libor offences. However, there is a distinction between transparency and regulatory overreach, which may drive market-makers and participants away, harming liquidity and transparency.

The prospective flight from commodity trading and the wider fall in FICC trading revenues must act as a reminder to legislators and regulators that their function is to improve markets, not regulate them out of existence.

Tony Woodcock and Alan Ward work in the regulatory litigation practice of law firm Stephenson Harwood.

PLEASE ENTER YOUR DETAILS TO WATCH THIS VIDEO

All fields are mandatory

The Banker is a service from the Financial Times. The Financial Times Ltd takes your privacy seriously.

Choose how you want us to contact you.

Invites and Offers from The Banker

Receive exclusive personalised event invitations, carefully curated offers and promotions from The Banker



For more information about how we use your data, please refer to our privacy and cookie policies.

Terms and conditions

Join our community

The Banker on Twitter