Oral evidence: Manipulation of Benchmarks, HC 491Wednesday 2 July 2014

Oral evidence, 2 July 2014.

Witnesses

Rhona O’Connell, Head of Metals Research and Forecasts, Thomson Reuters, and Alberto Thomas, Partner, Fideres LLP, gave evidence.

Chair

Thank you very much for coming to give evidence to us this afternoon. Can I begin by asking you, Rhona O’Connell, whether you think that market participants are aware of these conflicts of interest faced by banks that are part of the fixing process?

Rhona O’Connell

There has been an increasing amount of debate about it over the course of the last 18 months or so, I would say. There is one camp that is—

Chair

Sorry, let me put it slightly differently. Were they aware of this prior to 18 months ago?

Rhona O’Connell

There is a big debate in the market and a lot of people say that there is no conflict of interest; there is another camp that says that there is. The LIBOR problem has focused everyone’s attention, obviously, and as a result there is an increasing amount of conversation through the markets as to whether there are conflicts of interest or not.

Chair

How can it be claimed that there is no conflict of interest?

Rhona O’Connell

Would you like me to run through how the fix itself works? That might help to explain.

Chair

We have a rough idea, but if you think you can illustrate how it can be reasonably claimed that there is no conflict whatsoever, that is something we should have on the record. Is that your view, by the way?

Rhona O’Connell

I cannot say for certain that there is no conflict, because I have not worked with the fix.

Chair

Then there is scope for a conflict of interest?

Rhona O’Connell

There is scope for it; I cannot possibly say that there is not, because you will find that I have—

Chair

Have market participants been aware for years that there is a scope for a conflict of interest?

Rhona O’Connell

I would say that anyone with any experience and who thinks deeply about it would be prepared to accept that there is a possibility of a conflict, yes, because a bank may have a proprietary position that would go against all of that.

Chair

That has been evident for years?

Rhona O’Connell

I would have thought so.

Chair

In that case, why has it been tolerated for so long?

Rhona O’Connell

That I do not know.

Chair

Is it back to the question that Steve Baker asked: this was an old boy network, the legacy of an old boy network, where it is based on trust that has long since been displaced by a more cut-throat culture?

Rhona O’Connell

My understanding of it is that when a bank receives an order for gold to be bought or sold through the fix, they are essentially contractually bound to fill the client at that fix. It is very similar to the way the London Metal Exchange works. So a bank will take an order and that has to go straight through to the fixing process. The bank is essentially on risk over the period of time from when the order is received to when the price itself is fixed, because you are required to fill the client at that fixing price. Essentially, as far as the fix is concerned, the fixing members are facilitators. Where it is a potential problem is if they have positions of their own.

Chair

If they have positions of their own or if they are aware of advance positions?

Rhona O’Connell

Yes.

Chair

Defenders of the gold fix point out that they have to fill the buy or sell orders at the fixing price. That is okay, but it still leaves the potential to manipulate a benchmark price through real transactions towards a single, very large, strategically-timed buy or sell order in order to fix the market. Isn’t that what was going on at Barclays?

Rhona O’Connell

Up to a point. It is important to bear in mind that it is an auction process, and at any stage during the fixing process, which can take anything from three minutes to much longer—the record is an hour and three-quarters on Black Monday in 1987—any interested participant, be it a client of the fixing bank or a client of another bank who has submitted orders through to the fixing bank can change their order, they can pull it completely or they can put on a new one. If there is a substantial amount of buying going through the fix, which takes the price higher and higher because it is out of balance, ultimately you can only fix if the buy orders and sell orders are pretty much matched to within a tolerance of 50 bars, which is 2,000 ounces. If there is a lot of buying going through the fix, the price will be raised accordingly until there is sufficient selling interest to match.

Chair

Do you think that the FCA acted in a timely fashion or do you think they could have been on this earlier?

Rhona O’Connell

With respect to?

Chair

Their investigation. Were you here for the earlier questioning?

Rhona O’Connell

Yes, I was.

Chair

I asked the same question effectively of the FCA.

Rhona O’Connell

It has taken a bit of time, to be perfectly honest. My personal opinion, as opposed to an educated opinion, because I am not a regulator, is that when the—

Chair

You are very well-informed.

Rhona O’Connell

Thank you.

Chair

And close to this market on this very point, so your view is of some value. Do you think that they should have gone into this earlier or do you think they did it in a timely manner?

Rhona O’Connell

I would have thought that once the problems came into public knowledge with respect to LIBOR that everything should come under closer scrutiny.

Chair

They were slow out of the traps after LIBOR, is that your view?

Rhona O’Connell

I would say that, yes.

Chair

I have not asked you any questions, Mr Thomas, but again, can I ask you a question similar to the one I asked Rhona, which is—

Alberto Thomas

Absolutely, go ahead. You will not get a corporate answer from me, sir.

Chair

whether there is anything there that you have heard in those exchanges that you want to take issue with and whether there is anything you want to add, rather than my going through—

Alberto Thomas

I would have loved to be on the previous panel, but unfortunately I cannot answer every single question, Chairman. In answer to the previous question, yes, I agree with Ms O’Connell, absolutely, yes. The evidence was there, and as Mr Love said before, in order to manipulate a benchmark, you need to have means, motive and opportunity. The seeds are there not only on gold: we have had them in LIBOR; we have them in FX. I can tell you that we work on all of those and we have now another list of five or 10 that we are going through in due course. The situation is the same across a lot of financial markets, because these markets have all evolved throughout the last century, the information transmission mechanisms have changed and the speed of transmission of information across the markets has changed radically from 1919. When we look at the LIBOR or FX, the WM/Reuters fixing on FX, or whether we look at the London fix on gold or silver or gas or Baltic exchange or whether we look at ISDAFIX—and I can go on—the problem is that a lot of these markets present similar problems. The means to manipulate them are there. It does not mean that they are manipulated as markets. In a lot of these benchmarks, there are flaws in the design. It is impossible, from my perspective, working on trying to identify whether manipulation has occurred. In a number of markets, like the gold markets, we have no access to transactions that occur in the fix. We only have access to the futures markets. I will just give you an order of magnitude even when we can get access: if I want to do an analysis on the future markets, I pay £500 to access to all the transactions for the last five years microsecond by microsecond. If I want to have access to quotes in the physical gold market, I have to spend about £20,000, £25,000, and I only get quotes; I do not get any volumes or any actual transactional data. It is very, very hard to identify whether manipulation occurred, but the means is there, the opportunity is there, and if there is a conflict of interest in certain situations, or if on a certain day the dealers who submit the quotations or make the submissions to the panels have an economic interest, then the possibility is there. It does not mean that they do it all the time. As a matter of fact, as we worked across through all the benchmarks I mention, the ratio is approximately similar. In other words, what we identify as a ratio in terms of number of days when we are into that potential possible manipulation to the overall number of days is roughly the same. Therefore, it does not mean that they do it every day; they do it opportunistically, and sometimes they do it up, sometimes they do it down. They are agnostic. That is what we found.

Mr McFadden

Is this how a market should work, this process of five people on a phone call?

Alberto Thomas

Now we have four. You are absolutely right. The gold market is quite unusual, and if I go through, going back to the one of the questions that has been asked before, does it meet the 17 principles or whichever other sets of principles we want to take—the GFMA is another good set of principles—the fact is that the gold is probably one of the worst.

Mr McFadden

Why is it one of the worst?

Alberto Thomas

Because it does not tick any of the boxes. If you go, for example, through the list of what those criteria are, it does not have good governance; there is no way to audit what is happening on that call. There is no data transparency, so no one else can question whether the fix is correct or not. It is a tiered market. You have four people or five people on a call and then you have another market that keeps trading in parallel during that period of time. The evidence we found is that there is so-called leakage of information. What happens in the first moment of that call is a very, very good indicator of where the fix is going to be. In other words, nobody should really know what has happened on the call, but the whole market ends up knowing, because, as it was described before, you have those five banks on the call. Each of those five banks have behind them brokers and other banks, which are not members of the panel, and then each of them has clients, and all of them are on the telephone and all of them are being fed information of where the orders are. This information feeds through the market, to the futures market, so effectively you have a massive potential for insider trading in the market and market manipulation. It does not mean it happens every day, but the opportunity is there.

Mr McFadden

Let me ask you about that. What you have outlined is the potential, the means by which the market could be manipulated. Is it your belief that that potential is being used in the market and is being manipulated?

Alberto Thomas

The analysis we have done has concluded that there is a very strong indication of manipulation, yes.

Mr McFadden

Tell us about secrecy in this, because you have mentioned that it is quite hard for someone to follow this closely; you have to pay these fees to understand what is going on. What is all the secrecy about? Again, a market should be an open thing, by definition, where a product is bought and sold. Why is there so much secrecy?

Alberto Thomas

Some markets have evolved again over time. The gold market used to be very much discussed around the table in 1919, and that has been exploited somehow. It is no longer the case. There is a possibility to have a lot of these markets, over the counter markets, moving on an exchange and there is clearly a lot of interest by the dealer community to keep control of the information. Information is money. Also, if you want to be a member of the panel that had a prestige element—maybe it had it, it no longer has it—it had reputational importance for the banks who are sitting on the panel, because they had a very important role in the market and that was bringing business to them, both from a marketing perspective, brand perspective, but also purely for the fact that everyone had to channel their orders. If they wanted to trade at a fix, they had to channel their order through one of these five banks, so that brings business. Also, there is an interest to keep the market as an over-the-counter market, but this is true not only for gold but for a number of other commodity markets as well or other derivative markets, which are still over the counter.

Mr McFadden

Is the heart of this problem the problem that the Chairman opened with in today’s session, that we have benchmark prices being fixed by people who have an interest in manipulating those prices through their own trading books? Is that part of what is going on? Is that a good way to understand it?

Alberto Thomas

That could be a driver. Ultimately, all of the dealers have a conflict. They are one of the major trade counterparties on the futures, on the COMEX futures in gold, and they are at the same time sitting on the gold-fixing panel, the members of the London gold fix, so there is this conflict of interest. It should be dealt with. There are regulations in place.

Mr McFadden

Pardon the pun: how can this be fixed? What reform would you like to see? If you were designing an honest market or a more transparently honest market that was less susceptible to manipulation that the one that we are talking about, what would be its key features?

Alberto Thomas

I think there are three elements. One element is what is being done currently, which is introducing better regulation, better governance around the benchmark, and I think the set of principles laid out by IOSCO are very good. There is no problem with that. The second pillar should really be enforcement, and that takes the shape of two different forms. One is definitely the regulators. They have a very important role, and I am not sure they have the resources, frankly, to enforce in the same way as their US counterparty is doing. The third aspect that I see all the time is we are involved in disputes around benchmarks—we are leading experts on a number of class actions in the US on this topic—and it is that there is a very big discrepancy between the UK and the US, as you know, from a legal perspective. We have pension funds in the US that have enshrined in their statutes a fiduciary duty—there are pensions here who have lost billions of dollars in these cases potentially, if they are proved right—and they take it upon themselves to act and enforce those rights. Another part of what we do in the UK is to—[Interruption.]

Chair

We will have to adjourn the hearing and we will resume in 10 minutes. Sitting suspended for a Division in the House. On resuming—

Chair

Thank you very much indeed, both of you, for your patience. Pat, you had the floor.

Mr McFadden

Mr Thomas, I think you were just coming to the end of an answer, outlining some key features for remedying some of the weaknesses you see in the current situation. Do you want to just finish your point now?

Alberto Thomas

Thank you, yes. I was saying two pillars, the first one definitely regulation. The second one I was saying is we seem to have a reticence in this country, and in Europe in general, in terms of the investment community—institutional investors, pension funds, insurance companies, the financial sector in general—to enforce their fiduciary rights in these types of cases. That is a big obstacle and that is why we see a lot more litigation in this area going on, on the other side of the Atlantic, than we see in Europe. That is another important point. In particular, apart from the code of conduct on gold, as we touched on gold but we could talk about the other benchmarks as well, I think there is a very important flaw in the gold fix construct, which is the way this auction works. Earlier, there was a question about the length of the call. On average, it lasts 10 minutes. Sometimes, it last up to two hours, very rarely, but one hour occurs quite often. Now, as I said, there is this leakage system where the information that is discussed on the call gets transmitted to other market participants and influences the futures market, the derivatives market, at the same time, which is a problem. The fact is that no one commits. The participants who say, “I want to sell gold,” or, “I want to buy gold at a fix,” do not commit at any time to transact at any level. Therefore, you have this back and forth during the auction where they can revise their orders and say, “No, at this price I am not in,” or, “At this price, I am in.” The way an auction like the gold one is supposed to work, it should give, at every pricing point around today’s level, what is my interest to buy, what is my interest to sell and these are my orders, not that I can revise those orders back and forth during the call, if that makes sense. It is a very flawed design in terms of the way it works.

Mr McFadden

You said there were other benchmarks that you had concerns about, too. The regulator has been a little reluctant to talk to us about the potential manipulation of other benchmarks, at least by naming them. Let’s go back to where I began. For our constituents, they expect a market, if that word is properly and plainly understood, to be an honest process of buying and selling, which gets to a price. What other benchmarks, other than the ones that have been in the public domain, and for many people this began with LIBOR, although these things may have gone on before that? We have LIBOR out there. We have gold out there. We have foreign exchange out there. What other things would you suggest a committee like this or politicians and regulators should be interested in? Would it be the oil price? What other benchmarks?

Alberto Thomas

The oil price, yes. There is already a lot of evidence out there and, at least in the US, there is already litigation going on on that. We have found evidence on other interest rate benchmarks that are of big relevance, I think, to individuals in this country because on some occasions everyone has exposure to fixed interest rates through mortgages or other investment products. In particular, I mentioned before the ISDAFIX, which is the equivalent of LIBOR for long-term interest rates. I would recommend that you look into that. That is one.

Chair

Is there anything you want to add? You have been quiet now for a number of exchanges?

Rhona O’Connell

Thank you, sir, yes. I think one of the most important areas, and Mr Thomas has already touched on this, is transparency. When the bankers or their clients are putting orders through to the fix it is only ever a net position that is declared. You may declare yourself to be a buyer of, for the sake of argument, 10 bars, which is 4,000 ounces. That is a net position when you have aggregated everything from your clients. You could be a gross buyer of 110 bars and a seller of 100, but you are only declaring the 10. There is a lack of transparency and a lack of clarity about the actual volumes that are involved in the fixing process at any one time. That should be addressed.

Chair

This whole subject is one of those stones which, when you turn it over, you find a good deal more and each question leads to an answer that leaves one a little more concerned and that answer does, too, and certainly need further thought.

Steve Baker

Why is it that the gold market continues as it does? Why does it continue as OTC plus the fix?

Rhona O’Connell

One of the senior dealers in the market said to me recently that the stop price is basically the futures price plus an exchange for physical. I think he was basically saying that he thinks the futures markets are probably more influential than the physical market per se. I can understand that because of the volumes that go through and because of the nature of how a futures market works. If there is a lot of selling pressure, you can hit sell stops and that can have a disproportionate effect on the price as against the underlying physical market that lies behind it in London. To answer your question directly, it has been sustained in this way for many years because, funnily enough, of lack of transparency as much as anything else. If you trade in the OTC market obviously your counterparty knows what you are doing but nobody else does, which is one of the reasons why the central banks use it, because central banks do not stand in the gold market in order to be seen.

Steve Baker

Who would benefit and who would lose out from gold being traded on a regulated exchange?

Rhona O’Connell

I would have thought the whole market would benefit, personally.

Steve Baker

You think the whole market would benefit?

Rhona O’Connell

I would have thought so.

Alberto Thomas

It depends from which point of view, short term or long term. I agree that from a perspective of the common good, yes, everyone would benefit. The ones that would probably lose out in the short term are the four or five dealers, yes.

Steve Baker

Why does a modern exchange not just emerge spontaneously among either the current players in the market or among competitors? Why does it not just naturally move to an exchange basis?

Alberto Thomas

In some cases, it would like to move but it can’t.

Steve Baker

Why can’t it?

Alberto Thomas

I do not know if you looked at all into the credit default swap market. There have been specific allegations of collusion by the 13 or 16 banks that control the market in order not to license the documentation or the indices or the information to other incumbents who want to trade those products. The allegations are that the Eurex Exchange in Europe and the CME in the US wanted to set up an exchange for credit derivatives and they were not allowed.

Steve Baker

Could I ask you to comment on the scale of the market? Is that a factor in preventing people from moving to other mechanisms, the fact that only a few people trade gold in the quantities required to participate?

Rhona O’Connell

There are only a few market makers who participate in the fix, but there is any number of organisations or individuals who are involved in the market itself. To go slightly off at a tangent and refer to silver for a second, one of the fixing members currently has 320 counterparties who have contracts with them for whatever tenure it may be based around the silver fix. It would be more for gold.

Steve Baker

Just reflecting on the Plunkett case for a moment, wasn’t the issue there that the particular individual manipulated the market for the purpose of loading the dice against somebody to whom he had sold a derivative? The problem was not so much the participation in the market, which it seems to me is a quite clearly defined process. It was the fact that the market participant had an ill intent. Wasn’t that the problem?

Rhona O’Connell

Yes. He stood to lose less by exposing himself through the fix than he would have done if the digital option had been triggered.

Steve Baker

What would you say to people if, say, five organisations or five individuals want to get on the telephone and auction, in a defined way, a lawful commodity? Why should they not just be able to do that? That is what we are talking about. This is an auction to a defined process among consenting adults with lawful goods. Why should they not just be able to get on with it? Why should there be any move at all to move them to a regulated exchange by force?

Rhona O’Connell

To an extent I think you have answered your own question in the sense that you have just referred to the Plunkett case. He bid the market up, then he came away again and then he bid it up again. I am sorry, other way round.

Steve Baker

Yes. Forgive the slightly loose language, but is it not possible always to have effectively fraudulent behaviour in markets? We do not abolish markets just because some participants are fraudulent.

Rhona O’Connell

No, indeed. Philosophically speaking, any free market is ultimately potentially open to manipulation.

Steve Baker

Is there not just too much concentrated corporate power in this particular market?

Rhona O’Connell

On the basis, as Mr Thomas was saying earlier, that there is a prestige and there is a certain amount of remuneration that comes through to the fixing members, then you could argue that that is the case, but it is important also to bear in mind that there is any number of market participants who will be taking part in the fixing by virtue of having their orders, not necessarily with the fixing members, but with other bullion banks who then reflect them into the fixing room.

Steve Baker

To what extent is the leasing of gold relevant to this process? Should it be made transparent? How much of the traded gold is leased?

Rhona O’Connell

That would be very difficult to do. It should be possible. It would take a lot of work. There is a degree of conspiracy theory to the effect that there is a lot of leased gold from central bank holdings and that we do not know where it has gone. There are arguments to the effect that, because gold turnover is so very much larger than the actual underlying amount of metal in the market, there is scope for manipulation on that basis, because it is being leased and nobody knows who has it. That does not carry that much merit, to be perfectly frank, because you can generally trace the path that the metal has taken.

Steve Baker

Since you mentioned central banks, my experience now is that there is very rarely enough competence anywhere to carry out the conspiracy, but it is a fact that central banks do hold large amounts of gold and do co-operate with one another internationally as well as acting on their own account. Do you think that the central banks are a relevant player in this particular market?

Rhona O’Connell

In terms of the amount of tonnage that they operate with, they are nowhere near as big as they used to be. In the 1990s, in particular, there were several series of transactions driven particularly by Belgium and the Netherlands, latterly Switzerland and the United Kingdom, where substantial amounts of tonnage were put through into the market. They are much smaller now. In fact, they are now net buyers as opposed to net sellers. Where they would stand in the market is to ensure liquidity. Generally speaking, if they are trading, it is because they are doing it for the diversification of their foreign exchanges and managing the fiscus.

Steve Baker

Just thinking about the tonnage, I understand that last year the Shanghai Gold Exchange saw a 2,100 tonnes go through and I also understand that, excluding Russia and China, the rest of world production went through China. Is the whole gold market just moving east now?

Rhona O’Connell

Yes.

Steve Baker

What does that mean for London and this whole conversation?

Rhona O’Connell

The Shanghai Gold Exchange has just announced they are going to launch a futures contract in, hopefully, September. There is scope for both that contract and for London and for COMEX and so forth. London is the centre of the market partly through history. It goes back to Moses Mocatta first trading in 1717, I think it was, or 1697, for diamonds. It is basically through history that London has been the centre. There was originally just the one fix at 11 o’clock in the morning. In 1968, that was changed to 10.30 am and 3 pm as the starting points. The rationale behind that is that London sits in the middle of the time zones, so London can feed the Far East at the start of the day and then feed into the United States later on.

Alberto Thomas

If I can add to that, you are absolutely right that gold trades as a currency. It trades throughout 24 hours a day across the globe, but liquidity varies greatly and the peak of liquidity is around the 3 pm London fix.

Steve Baker

It is a fascinating thing you just said there. I am sitting here with a one-tenth of an ounce gold Britannia in my hand and you just said gold still trades as a currency.

Alberto Thomas

It does.

Steve Baker

Can you explain what you meant by that?

Alberto Thomas

It is a currency. It is priced as a currency. It is seen by a lot of investors as the ultimate hedge against inflation or as a storage of value. It is a currency, and particularly one of which there is a limited amount around, where central banks cannot create any.

Steve Baker

The history of this benchmark seems to correspond fairly closely to the monetary history of the world since the end of the classical gold standard. To what extent do you think the situation in which we find ourselves is a legacy of the monetary role of gold?

Rhona O’Connell

I think the fact that we no longer have a gold standard has meant that there has been—shall we say?—scope for laxity in physical discipline because you do not gold backing currencies any longer.

Steve Baker

You are my new favourite in saying that. I am sure that is right. I think I probably want to leave it there, Mr Chairman.

John Mann

In your view, is there an imperative to sort out some of these markets, not least the gold and silver markets, before London loses out permanently and forever to China? In other words, should we see it as an imperative to be pressing and pushing for the kinds of things you have talked about, transparency and so on—let us call it generally sorting out the market and the reputation—or is it of no concern?

Alberto Thomas

I am happy to answer first.

Rhona O’Connell

Yes, of course.

Alberto Thomas

As I said, we work across Europe. We do work in the US. We work in Asia. I have to say that people are quite shocked when they look at London markets in general by the lack of action in trying to reform the benchmarks and fixing them. It is seen as a weakness. I think we are very often worried about the importance of the financial sector to the UK economy. We should be more worried about the possibility that we will lose the dominance of the financial sector in the UK if we do not make it transparent and suitable to today’s demands by the international investment community, otherwise they will bring in someone else.

Rhona O’Connell

Yes, I agree. The only slightly different complexion that I would put on it is that the rest of the gold market is, to a degree, fragmented. There is the Shanghai Futures Exchange, the Shanghai Gold Exchange, New Delhi, Mumbai, London obviously, New York. There are a lot of exchanges out there and 90% of the physical trade in the gold market is what is known as LOCO London. Essentially, London certainly has the lion’s share of the physical market without a shadow of a doubt, but that does not mean that we should be complacent about it.

Chair

Mr Thomas, in relation to total volumes, what proportion do you think, on the basis of what you know, are or may be rigged?

Alberto Thomas

In gold specifically, again I have to be a bit careful. I will give you a range. We think in terms of the number of days where we found evidence. We analysed it carefully between 2010 and the end of 2013. We think a range between 10% and 30% of the days and this is consistent with what we have seen in the foreign exchange markets and other markets as well, with a caveat, as I said: we only have the publicly available information.

Chair

This is not just an isolated odd case, now and again?

Alberto Thomas

Not at all.

Chair

We are talking about endemic rigging?

Alberto Thomas

The FCA finding and the fine—it is one of the cases that was captured by our models and it is exactly the type of behaviour that we predicted could happen.

Chair

Which is back to this point when you said there is the opportunity there, you cannot be sure it is there, but once the opportunity is there, can’t you be pretty confident it is there?

Alberto Thomas

That is correct.

Chair

Once there is an incentive to enable people to rig a market and get away with it, you are very likely, sooner or lately, to get a rigging of it.

Alberto Thomas

Absolutely.

Mr Love

Mr Thomas, I don’t know whether you were present for the first session—

Alberto Thomas

Yes, I was.

Mr Love

when Mr Bailey from the FCA mentioned a consultation being organised by the Royal Gold Council to devise a replacement. What do you think of that process?

Alberto Thomas

Again, I am not involved in that consultation, so I only have the same information you have. On the surface, what they asked for makes perfect sense and I think, on the surface, the current fixing mechanism satisfies some of those criteria. They need something that is not a reference price. They need a price that producers, central banks or whoever, the end users or investors in physical gold, can transact. They need an actual price at which to execute transactions, so that is one very good criterion. They ask for transparency. They ask for auditable benchmarks. These are all good criteria, and as I said before, they are all captured by the IOSCO principles and I do not think that anybody debates whether those requirements should be embraced or not. The question is how to do it. I have seen the proposals around the reformation of the silver fixing and they do try to focus, it seems to me, on fixing one part of the problem, which is the transparency of the auction mechanism. That is definitely important and we need to be able to see what happens, because in gold we do not know if any transaction happens at all. We need to have that transparency, but there is a lot more to it, as I said. For example, the timing; there is no reason why we should wait for 10 minutes or an hour or an unlimited amount of time to get the pricing. We should be able to fix that and so there is a lot more than just getting transparency, I think.

Mr Love

To what extent is it motivated by competition with the London Bullion Market Association?

Alberto Thomas

There is competition with the London Bullion Market Association, but—

Mr Love

Have they stolen our lead on the London bullion market?

Alberto Thomas

I don’t think so. Eventually, the members of the London Bullion Market Association will have to agree to whichever proposals are put forward. I do not see it that way, personally.

Mr Love

You mentioned earlier that you thought regulatory scrutiny, bringing it into the regulatory ambit, might be the way forward. Do you think that the FCA and the regulators in this country have an obligation now to step in to sort this problem out? After all, there are quite a lot of people who think that the case that was taken recently is responsible, to some extent, for the difficulties now in the marketplace.

Alberto Thomas

There are two answers to your question. The first is that definitely there is a problem in the current system where the fix seems to be, “Let’s bring in front of the court one trader and he is responsible. It an isolated case and let’s be done with it.” I do not think that is the right approach. It is not an individual case. This is systemic failure. That is part of the answer, but I do not think, again, that regulation in itself, unless you give to the FCA incredibly more resources than they currently have, can investigate day by day the behaviour of every trader. That is just not possible. The market has a very important role. We are seeing it, for example, in the high-frequency trading scandal, which I don’t think has hit the news probably here as much as in the US, but that has been going on as well and we have seen that the market has fixed itself in a way. The market has decided that they can create an exchange that cannot be tampered with, where high-frequency trading cannot take place, and this has been a market-own initiative. It has been a new regulated exchange that has emerged and through which a high-frequency trader cannot transact because their tactics do not work. I think that the market should keep people accountable. It should be the shareholders of the bank and it should be the pension funds that pursue the dealers when they lose money. It should not just be the regulators with their stick going around and finding individual traders liable for it. That is a very important part of the problem and it needs to be enforced, absolutely, but it is a much more complicated problem. You need to try to find ways to introduce more competition.

Mr Love

But does the regulator have a role? In other words, should they be insisting that whatever the market comes up with, whatever the World Gold Council or the London Bullion Market Association comes up with, conforms to the IOSCO principles and delivers what would be public trust in that marketplace to have an objective gold fix?

Alberto Thomas

Absolutely.

Mr Love

Let me ask you just one final question. Given that we cannot expand the regulatory orbit around every single benchmark, do you think the most pragmatic solution to the problems in the gold market at the present time is a regulatory-led but market-imposed system that conforms to the IOSCO principles?

Alberto Thomas

Sorry, if that proposal is a solution to the problem?

Mr Love

It seems to me that the FCA was happy to allow the World Gold Council to go away and find a solution; then they will come back and comment on it. You seem to be satisfied with that, that the market needs to find a solution. What I was asking you was should there be a more activist role on behalf of the regulator to ensure that what the market comes up will meet with public concern over the—

Alberto Thomas

The job of the regulators is to enforce the fixing. I think the market will find a solution to the shortcomings of the current fixing. I do not think it is the job of the regulators to come up with a new methodology.

Mr Love

Ms O’Connell, do you want to add anything?

Rhona O’Connell

Thank you, yes. I agree with Mr Thomas in terms of the fact that the market will find its own solution. I did previously declare an interest, but I will iterate it. At Thomson Reuters, we are one of the organisations that are bidding for the administration of the silver fix, so I have a pretty good idea about what is happening there. If that process is a precursor to something similar for the gold fix then it should work out reasonably well because it is very much in the hands of the market. The LBMA conducted a survey of 400 market participants and the short outcome of this is that the people who are bidding for the fix are essentially in consultation with the market right the way through, trying to put something together that is what the market wants and that is not just the bankers. It is the miners, the refiners, the traders, the people who consume and so on and so forth. The silver market administrators are certainly listening to the market as a whole, so that should serve as a precursor to a similar process for gold.

Mark Garnier

Mr Thomas, just on the wider issue of the benchmark fixings, I am interested in your thoughts on a couple of things. Somebody has passed me a report by a company called Autonomous that is saying potentially with the FX fixing, which is slightly different from what we are concentrating on here, you could end up with a fine pool of some $35 billion. Do you think that sounds about right?

Alberto Thomas

It is a very large market. I think it is probably ballpark right. Our own estimate is probably slightly lower than that, but—

Mark Garnier

Much lower?

Alberto Thomas

No.

Mark Garnier

Do you think the banks see this as a fine by reputation or do they see this simply as a cost of doing business?

Alberto Thomas

I think so, yes.

Mark Garnier

The latter, the cost of doing business?

Chair

Which of those?

Alberto Thomas

They see it as a cost of doing business. They already have set aside money for a lot of these litigation cases that are being tried around the world.

Mark Garnier

A number of us are on the Banking Standards Commission, around the table at the moment, and we are trying to drive better standards. From what you are suggesting, it sounds like fining banks is not going to drive better standards in banks.

Alberto Thomas

No, I agree. I do not think it will.

Mark Garnier

That is very depressing.

Alberto Thomas

I personally don’t think so. That is why I think the news is not very reassuring from where we stand because it seems to me that the solution is to fine the banks but the fines we have seen so far are not prohibitive. They are not big enough. If you compare the UK fines to the US fines, already there is a big discrepancy there. That is the first point. The second point, as I said, is the shareholders do not seem to reinforce any rights on the banks. Where are the shareholders? Are they putting any pressure on management to fix things? I do not see it. I don’t see the pension funds saying, “I buy shares in RBS and Barclays. What are you doing? Are you fixing this?” There is no pressure exercised in this country by big shareholders on to the institutions that are the culprits of this behaviour.

Mark Garnier

Of course, a shareholder will simply vote with their feet rather than doing anything, so they will—assuming the closing print of the equity price—

Alberto Thomas

But the financial community is very closely knit. That is the problem. There is not much competition and people see that suing the bank is something that is going to ruin the business, because everybody depends on banks at some point in time.

Mark Garnier

Ultimately, of course, it is the consumer—

Chair

We pay.

Mark Garnier

It is the depositor.

Alberto Thomas

Absolutely. They do not have any direct relationship with the bank.

Chair

Just on that point, when you told us about the scale of the rigging on a daily basis—sorry, have you completed your questions?

Mark Garnier

It might follow on from this. You would have heard that I made these assertions about the equity market and the fixes. Do you have any experience of that at all?

Alberto Thomas

To be honest, we have not yet looked at the equity markets. I have heard about the types of areas you mentioned in the previous session.

Mark Garnier

That is not a surprise to you?

Alberto Thomas

No, it is not and I think, in due course, we will probably plunge in there, but there are higher priorities and there are other benchmarks or other prices that are much easier to manipulate than equity prices.

Mark Garnier

Of course, you are absolutely right. The equity element tends to be the smaller caps or the mid caps, as a result of which it is where there is less value to that market. None the less, would you agree that they would be doing it in terms of the incentive would be to try and get better valuations on stops when it could come in terms of when you have bonus valuations for the start or, alternative, it could be where you have derivatives maturity dates so you could have a result of helping on that type of thing? Can you think of any—

Alberto Thomas

There are possibilities and I think, ultimately, it comes down to the same. There seem to be, across all the benchmarks we looked at, a potential for conflict of interest and that could lead to front-running. It could lead to manipulation or lots of this behaviour. The explanations you gave are plausible. I do not know any specific cases that we need to look at yet, but I think that possibly it is another area that deserves further attention.

Chair

I just wanted to clarify. You gave us an estimate about the number of days that might be rigged. Are you able to give us any idea, on the basis of what you know, about the scale of the deviation from what would be the unrigged price?

Alberto Thomas

In terms of the amount by which—

Chair

Yes. In other words, by how much? We have been discussing—

Alberto Thomas

It varies by days.

Chair

Customers are ultimately paying for this. By how much are they being ripped off?

Alberto Thomas

It depends. It varies day by day and I would say—

Chair

We are looking for an average of the variation as a percentage.

Alberto Thomas

Up to $4 per ounce.

Chair

On a base of when it is varied up to 1,000 or—

Alberto Thomas

Yes, correct.

Chair

What are we talking about here? Are we talking about—

Alberto Thomas

0.5% or 0.4%.

Chair

We are talking about 0.5%?

Alberto Thomas

Up to. That is the maximum. That is what we have seen.

Mark Garnier

About five basis points.

Chair

Or five basis points.

Alberto Thomas

No, it is five—

Chair

50 basis points.

Alberto Thomas

40, yes.

Chair

40 to 50 basis points, okay.

Alberto Thomas

As a maximum. As you have seen on LIBOR, it varied.

Chair

You have both told us a pretty depressing story, haven’t you? You have told us the market has the potential to be rigged; that it is not remotely competitive enough; that where the potential exists for it to be rigged it is likely to be; that 10% to 30% of the days are likely to have been rigged; that up to 40 basis points may have been extracted at customers’ expense; and that regulators could and should have acted earlier, particularly after LIBOR. Is there any reason, looking at this, that we should not be concluding that this is an appalling story?

Rhona O’Connell

I am not talking the corporate book here, I assure you, but there is a page on Reuters that carries the trying price in the fix and that is real time. Anybody who has a Reuters’ screen—I do not know whether Bloomberg does it as well—will be able to see the price that is being tried during the fix. There is transparency there.

Chair

You have opened another whole set of issues about the relationship between that and the fixes, but we are not going to go there now. Thank you very much for giving evidence this afternoon. I am sorry that the hearing was interrupted. It was extremely interesting to have your evidence. Oral evidence: Manipulation of Benchmarks, HC 491. 12