* Banks take stakes in LME gold contracts through new
* They promise to supply liquidity in return for revenue
* Built-in liquidity may give LME edge over U.S. rivals
* LME gold, silver contracts to launch on June 5
By Peter Hobson
LONDON, Feb 23 The London Metal Exchange has
reached a 50:50 revenue-sharing deal with a company founded by a
group of banks to promote trade in its new gold futures
contracts, sources said, aiming to overcome market scepticism
surrounding their launch in June.
Usually, exchanges merely consult potential users about
their needs when planning new financial and commodity contracts.
But in this case, the LME has opted for a radical departure from
normal practice as it tries to grab a piece of London's $5
trillion-a-year gold market.
Sources close to the matter told Reuters that the five banks
and a proprietary trader which are shareholders in the new
company have undertaken to bring guaranteed minimum levels of
trade in the gold futures.
Should they meet these levels, the project partners will
receive a half share of the revenue under an incentive scheme
designed to ensure the contracts have turnover, viability and
credibility from the outset.
"We're all committed to market-making and will at least
bring our own trading book," said a source at one of the banks
involved in the project. "It'll come with some built-in volume."
The sources gave few details of the arrangement. However,
one at a different bank backing the contracts said: "Do we have
incentives for it to work? Yes."
The LME, which is owned by Hong Kong Exchanges and Clearing
Ltd, hopes the arrangement will give its contracts
enough business to take off from June 5 despite doubts among
many brokers and gold producers.
It also wants to shoulder aside U.S. exchanges CME Group
and ICE which launched London gold contracts
last month, although they have yet to attract any business.
The LME's partners from the banking sector are Goldman Sachs
, ICBC Standard Bank, Morgan Stanley,
Natixis and Societe Generale. They have
founded a company called EOS Precious Metals along with
commodity trader OSTC and The World Gold Council, an industry
market development body.
Together they have invested several million dollars in
designing and building the spot, futures and options contracts
and formed EOS to receive their share of revenues.
The LME and EOS have also offered the deal to all other
market participants. However, London's two largest gold traders
- HSBC and JPMorgan - are missing from the
consortium, as is ScotiaMocatta, another big bullion
Robin Martin, head of market infrastructure at the World
Gold Council, said EOS shareholders would not get any
preferential treatment in terms of fees paid to use the new LME
However, he told Reuters: "There is a commercial arrangement
in place which reflects the fact that the EOS shareholders have
co-funded the build-out of this service."
The shareholders had invested in the project in terms of
cash and time, "developing the product model and consulting with
the LME over a drawn out multi-month process", he said, without
detailing the financial or trading arrangements.
The LME, Morgan Stanley and Societe Generale declined to
comment on the deal with EOS. Natixis, Goldman Sachs and OSTC
did not immediately respond to requests to comment.
REVENUES FOR LIQUIDITY
At the moment, London's gold trade is dominated by
over-the-counter (OTC) business conducted bilaterally among
networks of brokers, producers and consumers. Gold futures
trading takes place chiefly on the CME's New York market and the
Tokyo Commodity Exchange.
However, the LME and its rivals see an opportunity as
regulation of the market tightens, hoping this will force the
trade onto transparent, centrally-cleared exchanges.
Bigger banks, which rely on their wide range of business
relationships, stand to lose market share from such a shift
because exchange trading would make it easier for smaller
players to compete.
Gold dealers keep their volumes secret and no precise
figures are available, but analysts and traders estimate the EOS
shareholders may control up to 50 percent of OTC bullion trading
Under the deal, the EOS partners will pay an annual fee to
the LME, said a source at one of the banks involved. This
represents an advance payment for clearing services, against
which fees will be offset as the trades are transacted.
They will also promise to provide minimum liquidity levels,
and to buy and sell gold and silver to facilitate trading.
"There is a share agreement taking into account how much
volume you are contributing to the platform. If our volume
explodes, we make money on top of that as a shareholder," said a
source at one of the banks.
Societe Generale, Goldman Sachs, ICBC Standard and Morgan
Stanley have made larger commitments and investments than other,
smaller EOS shareholders, sources said.
Backers of the scheme note that clearing gold business
through an exchange will have regulatory advantages as it means
banks would have to hold smaller capital buffers.
"For every open position that a bank has with its clients it
has to set aside capital. If they net and clear it on the LME
they have no exposure and no capital requirements," said the
head of a brokerage in London.
Tighter capital requirement regulations are due to be
introduced next year across the European Union, although
arrangements for when Britain leaves the bloc have yet to be
Further pressure for change is coming from the United
States. London's gold trade - along with the rest of the City of
London - has come under greater scrutiny since a scandal over
the setting of Libor benchmark interest rates, and U.S. lawsuits
alleging rigging are pending against banks that set bullion
The partners hope the LME contracts will eventually attract
most of the hedging business between banks and brokers, which
accounts for up to 90 percent of the more than $20 billion of
gold traded in London each day.
Not everyone is convinced; brokers and gold producers fear
the futures will be too inflexible and costly. Sources at two
banks outside EOS said they would wait to see whether the
contracts gain momentum before deciding whether to use them.
"If the LME can provide liquidity, then that's where people
will go and so will we," said a source at one gold producer.
The LME plans to offer a much wider range of contracts than
its competitors do at the moment in London.
The CME is offering gold and silver contracts to connect
London with its established New York market. ICE runs the London
gold auction, which sets a global benchmark price for bullion,
and has a daily gold contract that will enable participants,
which include most of London's largest bullion banks, to clear
Neither set of contracts has traded since launching in
January. The CME said it was working with major banks to
synchronise their systems to start trading. ICE said it expected
volumes to rise after it begins offering clearing in March.
In the meantime, the EOS partners hope the shareholdings
will appreciate over time. "After a few years, possibly, we get
a nice windfall profit, but it's not a project to make profit in
the short term," said a source at one of the partners.
(Additional reporting by Pratima Desai and Jan Harvey; Editing
by Veronica Brown and David Stamp)