How a spot gold exchange will lead to transparency in pricing

The buzz around the launch of a spot bullion exchange is becoming louder, with the World Gold Council recently forming a steering committee — consisting of international bullion banks, the Indian Bullion Bank Association, the Indian Bullion and Jewellers Association, the All India Gem and Jewellery Trade Federation and the Gem and Jewellery Export Promotion Council — to prepare a blueprint for its roll out.

A gold spot exchange would enable market participants buy and sell gold in T+2 (trade plus 2) settlement cycle. Though there are several commodity bourses, they operate as futures exchanges, which are primarily used to hedge the price risk and take proprietary position on gold-price movement. On the other hand, a spot exchange would focus on price discovery and provide the entire ecosystem needed for the physical market.

The spot gold exchange is expected to bring in transparency in gold pricing and boost recycling, which will eventually bring down imports. With proper regulation and lower costs, the platform can also support the futures and options market, besides giving a fillip to the government’s Gold Monetisation Scheme and Gold Bond Scheme.

Surendra Mehta, National Secretary, Indian Bullion Jewellers Association, said the spot exchange will enhance accessibility as participants get to deal with many registered members on the exchange — this will reduce counter-party risk substantially.

Being a nation-wide platform, it will also enhance liquidity, and in the event of counter-party default, participants will get assured compensation from the margin collected.

With a structured contract size and quality assurance, the exchange will ensure that delivery is done smoothly, he added.

With an annual gold demand of 800-900 tonnes and an export potential of $10 billion, India’s gold industry is not able to realise its full capability due to several challenges.

The challenges broadly include: a lack of quality assurance, non-transparent pricing mechanism, fragmented market, finance constraints and regulatory issues. Currently, the regulation of the gold market is shared among the RBI, SEBI and multiple government agencies.

A single, dedicated regulator, formed under an Act of Parliament for the gold industry, would help in framing regulations that address the concerns of the various stakeholders and develop the market faster.

The proposed spot exchange needs to adopt international best practices and gain the trust of the participants. It should attract participation from across the country by keeping costs low and with clearly defined governance standards that are enforced.

The operating model of a spot exchange has a number of key elements, such as the trading platform, product specification, delivery location and vaulting services.

The exchange platform should maintain a central electronic order book and match the best and sell orders to minimise bid-ask spreads.

In addition, the exchange must disseminate information on the latest realised price in near-real time through the exchange’s own website, data service providers and news agencies to provide transparency for its operation, and also maintain a repository of all trades for reporting purposes.

To ensure sufficient liquidity and standardisation in trade, most global gold exchanges offer a limited number of standardised contracts. Going by global examples, gold bars of sizes 100 g and 1 kg are the most-common in the wholesale segment.

To avoid fragmentation of liquidity, trading can be initially launched in wholesale bars and smaller-size bars can be introduced over time. The Bureau of Indian Standards should define Good Delivery Standards for India, and the proposed exchange can partner with BIS to adopt these norms.

The exchange network should incorporate all the key regional hubs for delivery to facilitate access to a broad user base and allow a truly national approach.

Exchanges can either have multiple contracts from different delivery centres or have one contract with India as the delivery location and introduce tradable location premiums. The tradable location premium is intended to reflect the dynamic price premium of each location.

Mukesh Kothari, Director of RiddiSiddhi Bullions, said the spot exchange would largely benefit small jewellers as they pay heavy premium to short supply of gold in the market. A spot exchange can create a transparent pricing mechanism, and this can also be used as the ‘India reference’ price.

The exchange will enable the formalisation of the Indian gold market which, in turn, would improve price transparency and tax compliance, besides helping the government supervise the gold trade, he said.

Participation from institutional players such as banks is crucial to gain scale and build liquidity.

However, due to regulatory restrictions, banks are not allowed to play an active role in the gold market. There are restrictions on buying and selling gold in the domestic market, participation in the futures market, and in launching gold-linked products.

Moreover, banks can only hold gold as part of the statutory liquidity ratio requirements, which is not economical due to the lower yield from gold when compared to other liquid instrumentssuch as government securities. To truly incentivise banks to participate in the gold market and make it profitable, banks may also be allowed to hold gold as part of CRR (Cash Reserve Ratio) requirement.

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