There is a huge market in precious metals derivatives that will soon undergo substantial changes due to new regulations. This market is often the tail that wags the market for physical precious metals. From Alasdair Macleod at goldmoney.com:
The draft PRA rules complying with Basel 3 regulations have now been issued six months ahead of their implementation to allow banks to adjust for them in time. From now, senior bankers, their lawyers and bank treasury managers will be planning amendments to their business strategies accordingly.
As a division of the Bank of England, the Prudential Regulation Authority recognises the importance of gold trading in London and has inserted a clause into the new rules (Article 428f) which will allow the LBMA’s centralised settlement system to continue to function. But in line with Basel 3’s apparent determination to get banking’s exposure to uneven derivative positions substantially reduced, net positions in precious metal derivatives in the form of forwards and swaps will be penalised through their inefficient use of balance sheet resources and will likely be replaced by transactions fully backed by physical gold.
The LBMA has been thrown a lifeline but will likely have to refocus from forward derivatives to physical bullion backed trading. By responding positively to these developments, the LBMA and its membership can retain and build on their pre-eminent position in global precious metals markets.
This article points out that the market value of forward derivatives in gold is currently the equivalent of 8,675 tonnes. While it would be incorrect to think it will all translate into new bullion demand, there is little doubt that if Basel 3 leads to the demise of the London forwards market, it will lead in turn to a significant replacement in the form of physical demand.
This article also looks at the broader picture for banking in the light of the PRA’s new regulations as well as the specifics for precious metal derivatives.
The background to Basel 3
Investors are increasingly aware that in all international financial centres, banks are now being required to run their businesses differently under the new Basel 3 regulations. For the first time, regulators are now telling banks how they must fund their assets out of their liabilities. This is a major change, which from the beginning of this month is being applied in the US and the EU. It is scheduled to be introduced in the UK from 1 January 2022.