London's silver price benchmark is plagued by big, unpredictable fluctuations that risk undermining its credibility and may complicate efforts by the London Bullion Market Association to find a new operator, according to a Reuters analysis of trading data and 10 industry sources.
The benchmark is used by silver producers and consumers around the world, including jewellers and electronics firms, to price their contracts in the multi-billion-dollar a day trade. The figure generated at noon London time is intended to be a fair and accurate daily snapshot of the wider, fast-moving "spot" market. However, it has diverged widely from the spot price on a number of occasions since at least January 2016, leaving buyers and sellers with unexpected gains or losses, according to the Reuters analysis using Thomson Reuters data.
Between January 2016 and March this year volumes have risen as high as 12.9 million ounces and fallen as low as 200,000 ounces, while on seven occasions the benchmark has diverged from the underlying spot price by 10 cents or more. It has diverged by more than 5 cents on more than two dozen occasions, including five times in late March alone. This is highly unusual as the average divergence for the electronic auction is about 1 cent.
At the core of the problem are low volumes and the unwillingness of seven banks that execute trading orders to add liquidity by buying or selling silver during the auction to ensure the benchmark stayed close to the spot price.
Traditionally banks did so, but many changed their approach after the scandal over the manipulation of the Libor interest rate benchmark, according to the 10 industry sources. Banks are now unwilling to intervene beyond putting in orders beforehand, fearing this might be construed as price manipulation by regulators, the sources said. When asked about the volatility and its implications for the credibility of the of the benchmark, the LBMA said: "The LBMA takes seriously any incident that undermines the credibility of the benchmark auction."
"It is recognised that some banks' reluctance to amend orders once the auction has started has been an issue for the benchmark. The LBMA is hoping potential new operators can propose ways to enhance the auction process."
The seven banks are: HSBC, J.P. Morgan, Morgan Stanley, Scotiabank, Toronto-Dominion Bank, UBS and China Construction Bank. Scotiabank and China Construction Bank did not respond to requests for comment, while the other five banks declined to comment. The UK financial regulator also declined to comment. The banks' decision not to add liquidity has reduced the volume of orders in the auction and its flexibility, making the benchmark volatile.
The problems come at a time when the LBMA is looking for a new operator for the benchmark after exchange platform provider CME Group and information and technology company Thomson Reuters announced their intention to quit last month, saying new regulations had prompted a review of their involvement, without elaborating.
CME and Thomson Reuters told Reuters in a joint statement on Wednesday that they were committed to upholding the integrity of the LBMA Silver Price, and were working with all stakeholders to ensure its smooth operation through the transition to a new provider.
The administrators attempted to stabilise the auction in March this year by widening the acceptable gap between buy and sell orders, making it easier to set a price.
The price anomalies are denting confidence in the auction. One European silver trader, who spoke on condition of anonymity, said many of his clients now preferred to execute trades at spot prices rather than use the more volatile auction. On March 20, Toronto-Dominion Bank scaled back its exposure, according to three sources who said the bank told financial clients it would no longer take their orders to the auction because it feared the benchmark could lose liquidity and become more unpredictable.
Toronto-Dominion Bank declined to comment. Against this backdrop of uncertainty, the LBMA launched a tender for a new operator in mid-April and wants a new company or companies in place by autumn. Many market participants had speculated three years ago that a key attraction was that a successful bid could swiftly be followed by deals to run the much higher profile gold benchmark.
That carrot doesn't exist this time. The LBMA Gold price auction was awarded to Intercontinental Exchange (ICE) in 2015. "Everybody thought that silver was going to lead to getting gold, but now ICE has got the gold," said Michael Greenacre, chief executive of Autilla, which took part in a bid to operate the silver benchmark in 2014. "The cherry on the pie has gone."
Industry sources said there were likely to be far fewer bidders than the seven attracted when the electronic auction was launched 2014 and that it would be a far tougher sell because of the volatility problems and the lack of the gold incentive. The LBMA denies that, saying it has been approached by interested parties. It declined to give numbers or names.
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