Benchmarks in the spotlight: The impact on exchange traded markets

• Author: Angelo Aspris,Peter O'Neill,Sean Foley
• Published date: 01 November 2020
• Date: 01 November 2020
• DOI: http://doi.org/10.1002/fut.22120

J Futures Markets. 2020;40:1691–1710. wileyonlinelibrary.com/journal/fut © 2020 Wiley Periodicals, Inc.

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1691

Received: 31 March 2020

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Accepted: 31 March 2020

DOI: 10.1002/fut.22120

RESEARCH ARTICLE

Benchmarks in the spotlight: The impact on exchange

traded markets

Angelo Aspris

1

|Sean Foley

2

|Peter O'Neill

3

1

Discipline of Finance, University of

Sydney, Camperdown, New South Wales,

Australia

2

Department of Applied Finance,

Macquarie University, Sydney,

New South Wales, Australia

3

Department of Economics, Financial

Conduct Authority, London, UK

Correspondence

Angelo Aspris, Discipline of Finance,

University of Sydney, Camperdown 2006,

NSW, Australia.

Email: angelo.aspris@sydney.edu.au

Abstract

The Fix for precious metals is a global pricing benchmark that provides pricing

and liquidity provision for market participants. We exploit the gradual change

in the century old auction process to quantify the efficiencies related to more

transparent pricing. Our focus is in the market impact of this change on ex-

change listed products. We find that reforms to the Fix have reduced quoted

and effective bid‐ask spreads and improved overall market depth. The results

imply a positive spillover effect stemming from timelier and more accurate

pricing information. The conditions under which we observe the benefits from

transparency are related to product liquidity and the degree of market

segmentation.

KEYWORDS

benchmarks, fix, futures, gold, precious metals, silver, transparency

JEL CLASSIFICATION

G13; G14

There is no way to audit what is happening on the call. There is no data transparency, so no one can question

whether the Fix is correct or not—Treasury Select Committee 2014.

1

1|INTRODUCTION

Over the last decade wide‐ranging vulnerabilities in the architecture and oversight of benchmarks has been identified in

a variety of market benchmarks, including interest rates, foreign currency and oil. Following a chorus of concerns about

the fixing mechanism used in precious metals, the London Bullion Market Association (LBMA) set about transitioning

to a new system, beginning with the Silver Fix in 2014.

2

The antiquated auction system was succeeded by an electronic

solution, with significant enhancements to transparency. The electronic auction process was to provide participants

with more direct access to the auction as it ran alongside other live markets such as the “spot”bullion and derivatives

markets.

1

Treasury Committee:Manipulation of Benchmarks, HC 491 July 2, 2014, available at (http://data.parliament.uk/writtenevidence/committeeevidence.

svc/evidencedocument/treasury‐committee/manipulation‐of‐benchmarks/oral/11200.html) (accessed June 24, 2019).

2

The LBMA launched the LBMA Silver and LBMA Platinum and Palladium prices in 2014. The LBMA Gold Price was launched on March 2015 so

that all four precious metals were transferred to electronic auction platforms.

Price benchmarks are institutions that play a vital role in financial markets. They help to reduce asymmetric

information around the value of an underlying asset (Duffie, Dworczak, & Zhu, 2014). The “Fix”also provides the most

liquid trading opportunity for precious metals,

3

and its publication acts as the basis for pricing commercial deals and

retail products worldwide. It additionally provides a way for valuing holdings at central banks, ETF investment funds,

and trade inventories.

4

Benchmarks additionally contribute to the role of price discovery in financially linked contracts

(Caminschi & Heaney, 2014; Frino, Ibikunle, Mollica, & Steffen, 2018; Hauptfleisch, Putniņš, & Lucey, 2016). This

is not unexpected, since benchmarks are typically written into contracts, administrative regulations, and statutes

(Verstein, 2016). Adjustments to the structure of these benchmarks are therefore, paramount to a wide range of

participants. In this paper, we explore the impact of changes to precious metal benchmarks in the market quality of

exchange traded instruments.

The transformation of precious metal benchmarks from opaque dealer to open and electronic auction design,

characterized by higher levels of transparency and auditability, is a key ar ea of reform. The new fix ing mechanism

provides participants (both direct and indirect) with the ability to view pricing and order imbalance information that

was previously limited to a handful of direct fixing participants.

5

The dissemination of this information also now

occurs without delay and is provided via a network of decentralized data providers. The framework allows partici-

pants to segregate house and clients orders, providing a further layer of information to participants previously

withheld. In all other regards, the new system does not materially deviate from the old.

6

Regulatory responses such as

these are often predicated on the belief that transparency improvements will enhance the efficiency and fairness of

markets. However, evidence is both sparse and difficult to predict, because the effect of transparency can depend on

the aggregate amount of information produced about fundamental values, the degree of market liquidity, and the

fragmentation of trading.

Market transparency has been a persistent theme in electronic market design over the last two decades. Glosten

(1999) concludes that “transparency should lead to greater commonality of information, which means that adverse

selection becomes less of an issue.”Indeed, evidence provided by Boehmer, Saar, and Yu (2005) and Eom, Ok, and Park

(2007) supports this notion and is consistent with the theoretical models of Pagano and Röell (1996) and Baruch (2005).

In Pagano and Röell (1996), pretrade transparency allows market makers to learn from trades more quickly, and this

leads to more efficient prices and lowers trading costs. In Baruch's (2005) model, transparency increases the ability of

market participants to compete with specialists in the provision of liqudity, and this results in more efficient prices.

However, not all findings in the literature conform to this positive view. Madhavan, Porter, and Weaver (2005), for

example, find that increasing transparency negatively affects liquidity, arguing that a transparent process may increase

the reluctance of traders to post limit orders because of the implicit “free‐option”offer.

Transparency improvements can also generate significant spillovers effects. In Amihud, Mendelson, and Lauterbach

(1997), liquidity improvements are generated for stocks that transition to a new and more transparent trading me-

chanism, but significantly, correlated stocks (unaffected by the change) also experience similarly meaningful im-

provements. They suggest that asset pricing efficiencies for one security may facilitate “value discovery for other

(correlated) securities.”Bessembinder, Carrion, Tuttle, and Venkataraman (2016) use the introduction of the Trade

Reporting and Compliance Engine (TRACE) to show that transparency has positive spillover effects on nonaffected

bonds, with a significant reduction in trading costs on non‐TRACE eligible bonds for market participants. Hendershott

and Jones (2005) examine the effect of an electronic communication network (ECN) that ceased displaying its auto-

mated limit order book to participants for several exchange traded funds (ETFs). The authors show a deterioration in

market quality and price discovery following this regime shift, with significant opt out from these funds to futures‐based

alternatives.

In this study, we explore the market quality impact of transparency improvements on precious metal bench-

marks. We are interested in understanding how higher levels of disclosure around the pricing process for un-

derlying assets affects the trading environment of financially linked securities. Previous literature suggests that

opaque market structures could be more advantageous to informed traders (and conversely, more harmful to

3

Intercontinental Exchange (ICE) estimates that over $US100m worth of Gold bullion is traded in each auction. (Link)

4

As an example, the SPDR Gold Trust (GLD) adopts the LBMA Gold Price PM as the reference benchmark price for gold in calculating the net asset

value (NAV) of the Trust. Before that date, the Trust used the London PM Fix as the reference benchmark price in calculating the NAV.

5

Under the earlier system, participants could share information during the auction process with certain clients or their own trading desk.

6

The trading platforms log every change and update into the auction for all users, allowing for improved surveillance and protection from market

abuse.

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