Jan 292016

Since I’m partial to a bit of alliteration in my post titles, it is just as well that the Fix had a name change because there is a word beginning with F that describes what happened midday London yesterday (and that word is Farce – go wash your mind out with soap). Anyway, “storm of stupidity” is probably a better fit because it looks like a combination of price insensitive sellers using what now appears to be a closed-end fund.

Before we get underway, I want to address the manipulation argument. This was predictably raised by those looking for a simple explanation, seeing the price action as another Plunkett-style trade. I think that is unlikely in this case, as any trader attempting that post-Plunkett would certainly not be wanting to draw attention to themselves and only be looking for a few cents. Once you saw the price dropping dramatically and the fix process struggling to clear, you wouldn’t keep pressing on to leave a nice trail in what you know is a fix that is going to be investigated due to its extraordinary nature.

My first “stupid” is the people who put sell-at-market orders on. These people are most likely mining companies, particularly those for whom silver is a by-product. As I discussed here last year, they think it is safer to trade on a benchmark – safer in that if they traded the spot market and didn’t achieve the benchmark price they would get in more trouble for that then the times they achieved a better price.

I asked our senior dealer whether this fix farce would prompt such sellers to stop using the fix and let their brokers “work” their position in the spot market old-school style. He said no – generally they weren’t aware of the intra-day price movements and just took the benchmark as given. I suspect however that such a view is based on the assumption by the sellers that an industry benchmark is liquid and will represent the market price. Clearly this was not the case yesterday.

This leads us on to our second “stupid” – regulators/compliance. Adrian Ash reports that:

“Dealers blamed Thursday’s action on rules – decided by the compliance departments of banks and brokerages, and aimed at meeting the new regulatory regime – which block traders participating in the benchmark auction from “arbitrage” in other silver markets at the same time.”

A classic case of unintended consequences where regulators come up with simplistic solutions and end up throwing the baby out with the bathwater. How is a benchmark meant to represent the market if it can’t be connected back to that market? This means the LBMA Silver Price is sort of a closed-end fund without an ETF-style market making arbitrage mechanism to keep its price in line with reality.

It does raise the question of whether the CME/Reuters or the brokers have some duty of disclosure to tell their clients that because of the inability of brokers to arbitrage the LBMA Silver Price, the price they get may be at a discount or premium to the rest of the market. With the undoubtedly millions of ounces sold on the fix at an 80 cent loss, someone may try to sue someone.

This leads us on to the question of what were the bullion banks doing during the fix? In a situation where the banks can’t arbitrage during the process and there is a persistent buy/sell imbalance, then they have to take on price risk that when the price fixes, they are not going to be able to layoff the “market making” position they took on into the spot or futures markets at a profit.

The fact that the price spiralled down implies that the volume being sold was large, large enough that the banks were not confident that when the price fixed that they would be able to lay their positions off in the “free/open” market without moving the price down. It does beg the question of where were other market players to take advantage of such a divergence? I think the answer is that such trading is a tricky business as you can’t be sure that your order into the fix will balance the market and you will get set at that price – it is not a simple arbitrage where you know you can execute at two different prices, it is a much more dynamic process. Managing that risk is a skill set that, surprise, is probably only located within the LBMA market making banks. But they have their arbitrage hand tied behind their back (thank you regulators).

I think it is also important to note that the setting of the price of the auction rounds is automated. There is the capability “in exceptional circumstances” for the CME to “overrule the automated new price of the next auction round in cases when more significant or finer changes are required”. It would be interesting to know if the CME just let the algorithm run wild or intervened, although I note that Reuters, in addressing IOSCO Principles for Financial Benchmarks, say “No expert judgement will be levied – auction-based methodology”. Yes, brave new world, no meatbags required.

A contributor to this situation, by giving regulators intellectual “cover”, are those academics who failed to understand what market making is and the different roles of brokers and principals. In precious metals we had various academic papers that observed an interaction between the fixes and the spot and futures markets and presented it as if they had found evidence of manipulation when they had merely discovered arbitrage. In FX market this manifested as outrage about foreign exchange “rate-rigging” (eg here).

The problem for the CME/Reuters/LBMA is that if the sell-at-market sellers wake up and can’t be reassured that the silver fix has a mechanism to keep it in line with the rest of the silver market, then they will abandon it and the fix will die. But I can’t see how the fix administrators are going to be able to roll back regulatory/compliance requirements for “no arbitrage”. Maybe others will step in to perform that arbitrage. But then why can they “rip faces off” but not the banks saddled with being conduits for fix orders? Maybe regulators will want to regulate these 2nd tier arbitrageurs so there are only “real” buyers and sellers? And the 3rd tier? I wouldn’t be confident that regulators wouldn’t go down that absurd rabbit hole rather than admit they were wrong.

You’ll note I’ve used the word “fix” rather than “LBMA Silver Price” in this article. Its resistance to what seems to me to be a superficial cleaning up of the old fix – look at this new fix Mr regulators, its electronic, uses algorithms and we’ve stopped using the word “fix” and we’ve even made the price “easier to see. The traders wanted to have bigger fonts, so we did that” (yes, I kid you not). All the while, however, it was structurally deficient in the face of large buy/sell volume imbalances.

For institutional and other big money investors, this fix farce will just make them think that the silver market’s liquidity is a joke.


I wonder if CME is still “proud” of this new fix system? Well at least the bigger fonts will make it easier for people to see how much money they are losing.

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