For background information on bullion trading, see the Q&A at the bottom of this alert.
Singapore’s growth as a global commodity trading hub continues, with recent developments affecting the city’s role in the precious metals market. Demand for ownership of precious metal is growing in Asia, despite (or perhaps because of) falling gold prices. The demand is driven by increasing consumption in China and India, growing private investment demand across the region – with investors drawn by concerns over weakening currencies as a result of quantitative easing measures – and Asia’s high-tech manufacturing industries, which use platinum group metals in the production of display screens for hand-phones and tablet computers. The trend is supported in Singapore by government incentives, including the introduction last October of an exemption for precious metals transactions from Singapore’s 7% goods and services sales tax. Singapore’s reputation as a low-risk location to store high-value assets adds to its appeal. This client alert considers some of the implications of these developments.
Developments in Singapore Rapid development of the infrastructure to support bullion trading is currently taking place. Singapore’s vault capacity has increased substantially over the past two years. There are now three banks operating storage capacity in Singapore: JP Morgan, who has been operating a vault since 2010, Deutsche Bank and UBS, who opened vaults this year. The ANZ Group is also reported to be preparing to open a vault in Singapore. Meanwhile, the Singapore Precious Metals Exchange, a private online exchange, has been created to allow retail customers to buy and sell Singapore-stored bullion to each other. A new bullion production facility is due to open later this year, and there are reports of an intention to establish a Singapore gold fix – a means to benchmark bullion prices locally – which currently is dominated by the London-fix price. All of this contributes to Singapore’s emergence as a challenger to the traditional precious metal trading hubs of London, New York and Zurich.
What business opportunities are likely to arise? The primary business opportunity for Singapore vault-operating banks is in providing custodian services to clients based in Singapore and South East Asia. This will be an “allocated” market, i.e., the banks will hold the gold for their clients and it will not appear on the banks’ balance sheets.
The development of a market for delivery of bullion in Singapore – i.e., a “loco Singapore” market – will create further opportunities. Local non-vault-operating banks will have opportunities to provide custodian services to their own clients (through sub-custody arrangements with the vault-operating banks). Refiners will have opportunities generated by the demand for smaller sized bars, and coins that non-institutionalised investors require. Bullion-owning banks and traders will have trading opportunities arising out of the increased optionality that a
Singapore delivery base provides. And service providers such as logistics firms and insurers are likely to see increased demand for their services.
We discuss below some of these activities, and the contractual considerations that should be considered for those who engage in them.
Like other physical commodities, precious metals should be stored pursuant to agreements that impose upon the custodian and depositor appropriate duties. However, in practice, there is wide variance in how these are applied. In the London market, a practice has developed for banks to provide custodian services pursuant to “allocated” and “unallocated” account agreements. These are designed to accord with the practices of the London Bullion Market Association. London Precious Metals Clearing Limited (LPMCL) – an affiliate of the London Bullion Market Association – has produced standard form allocated and unallocated account agreements. To those unfamiliar with such concepts, the legal effect of these agreements can be confusing. Do they impose fiduciary obligations on the account provider as custodian? Is the protection satisfactory for the account holder? Who has title to the bullion? What insurance cover is provided, if any? What kind of risk exposure should an account holder factor into its analysis? Bullion owners in London and elsewhere have, in our experience, become more willing to challenge some of the established practices before handing custody of a valuable tangible asset to a third party. It remains to be seen whether the emerging Singapore market will follow the practices of the London bullion banks. The differences between the common law approach under English and Singaporean law, should also be considered as part of the legal analysis in such local custodial arrangements. Whatever form of agreement is used, depositors should not be afraid to ask searching questions before handing custody of a valuable tangible commodity to a third party.
Precious metal refiners convert the raw metal received from miners into ingots and coins, and recast bullion bars from the standard “London good delivery” specifications of the London Bullion Market Association, or other similar standards, to meet customer requirements. The first Singapore cast 1kg gold bar was unveiled by a Swiss refiner, Metalor Technologies, in June 2013. Businesses that require the fabrication or re-fabrication of metal into or from the London good delivery bar specifications (or equivalent) will need agreements to cover both the custody and fabrication services that the refiners will provide. Contractual practice here is again not uniform or particularly well developed. Refineries in some cases adopt the LPMCL model unallocated and allocated account contracts, which are not intended to cover refinery services. In other cases, no contracts are used at all, giving rise to significant legal risk for the owner of the bullion. Refineries and their customers should create agreements that are specifically tailored to the nature of the facility, the fabrication services and the location in which the bullion will be recast and stored. There are rules in certain jurisdictions that affect the refiner’s stock maintenance obligations, which will need to be taken into account.
Commercial opportunities may lead to a bullion dealer moving bullion from one location (colloquially known in the trade as “loco [London/Zurich/New York/Singapore, etc.]”) to another. “Loco swaps” permit unallocated bullion holdings to be transferred easily and without operational risk. Where, however, allocated metal, i.e., specific physical bullion bars, are to be moved, for example, for delivery to a refinery location or to bank or jeweler customers in India or China, agreements will need to be entered into with logistics companies to provide for the carriage of the bars (usually by air and land). In preparing these agreements particular attention should be given to the liability regimes, insurance obligations and the operational mechanics around the provision of the service. The risk of fraud and theft that arise with bullion transactions should inform the drafting from both the service provider and customer point of view.
Disposition – Sale, Repo, Leasing and Loans
Precious metals are peculiar as traded commodities in that they are sought both for end-use consumption as well as an investment asset, to be held over the medium to long-term. As a consequence they are the subject of a variety of transaction types. Bullion transactions involving forwards, options and gold interest rate derivatives in the OTC market are most commonly documented under either the LBMA’s International Bullion Master Agreement or the ISDA Master Agreement (which incorporates bullion-specific provisions to the Master Agreement through the Bullion Annex to its Commodity Definitions). Leasing and loans involve the commercial “loaning” of the metals to another party in return for the payment of interest, and are suitable for use with unallocated holdings. Consignment sale transactions involve a combination of elements of an outright sale and a loan. Other transaction types include the sale and subsequent repurchase of precious metals, in particular platinum, for a fee. The appropriate credit analysis and the availability of security will depend on which structure is used, where the assets will be located and whether/how they will be used in industrial processes. Care should be taken to ensure that the transaction documentation reflects the true legal nature of the transactions and the proprietary or security rights made available to the parties, which may not accord at all with what the commercial names, such as “lease” or “loan”, suggest.
Questions arise as to how bullion holdings and transactions should be treated for regulatory capital, accounting and trade reporting purposes. Lawyers will be required to help in answering some of these questions. The answers will impact on the cost of certain transactions with banks. For example, the implementation of Basel III is requiring banks to maintain capital in respect of their unallocated metals, which represent liabilities to creditors and could be deliverable upon demand but which would normally be traded and monetised continuously. The capital charges are dissuading those banks from building their unallocated deposit business. Likewise, institutions that are subject to Dodd-Frank requirements may be required to treat transactions that have an option to be cash settled at the election of only one party, differently from other bullion trades. Regulation is impacting opportunities in physical bullion business, and has the potential to do so particularly in Asia, where the regulatory environment is fairly nascent.
The increase in precious metals trading activity in Singapore presents opportunities for banks, miners, refiners, traders, consumer businesses and logistics firms. It coincides with regulatory developments that have a particular impact on precious metals transactions, given their place at the intersection between physical and financial activity. It also coincides with a development in legal practices and standards for documenting transactions seen in other geographical markets, as market participants become more attentive to their bullion businesses. Singapore is well placed to capitalise on and enhance these developments to facilitate a secure, liquid and competitive trading environment.
What is the LBMA?
The London Bullion Market Association (LBMA) is a trade association that represents the wholesale market for gold and silver traded in London. It informs the practices by which bullion is traded globally through setting common refining standards and bullion specifications, and encouraging the use of standardised trading documentation. London is the pre-eminent hub for trading physical bullion, wherever it is produced.
How is bullion traded in the London market? The London market primarily serves professional to professional trading between producers, fabricators, central banks and investor-dealers. The LBMA maintains Good Delivery Rules, which specify minimum bar sizes (400 ounces/12.5 kg for gold, 1000 ounces/31.3 kg for silver) that are beyond the requirements of most individual investors. Trading is done over-the-counter (OTC), i.e., on a principal-to-principal basis; there is no central exchange.
Who are the 11 market makers? Market Making Members must quote bid and offer prices to each other and to their clients upon request, throughout the London business day, in three main product categories for gold and silver – spot, forwards and options. They create the liquidity for the London market. The Market Making Members are Barclays Bank plc, Credit Suisse, Deutsche Bank AG, Goldman Sachs International, HSBC Bank USA NA, JP Morgan Chase Bank, Merill Lynch International Bank Limited, Mitsui & Co. Precious Metals Inc., Société Générale, The Bank of Nova Scotia – ScotiaMocatta and UBS AG.
How is bullion priced?
The LBMA provides benchmark prices known as the Gold Fix and Silver Fix. Buyers and sellers may choose to price contracts by reference to the Fixes, and to settle transactions by executing orders during the fixings. The fixings are an auction between a number of the Market Members, at which a price is established that matches together willing buyers and sellers. The fixings take place twice a day for gold, at 10:30a.m. and 3p.m., and once for silver, at 12p.m.
How is bullion ‘cleared’? Five LBMA members offer clearing services. Clearing in this sense means the execution of transactions in unallocated bullion. Transactions processed by each clearing member are netted together and then executed with other clearing members by book entry transfers, thereby avoiding the need to physically move bullion from vault to vault. Transactions remain principal to principal; this is not clearing in the usual sense of the word.
What is the difference between allocated and unallocated bullion?
Allocated bullion is physically segregated, identifiable bars, plates or ingots of metal “allocated” to a customer. Major dealers will usually hold it on their customers’ behalf under a custodial contract. Unallocated bullion is in effect a right to receive bullion, exercisable against the dealer that operates the unallocated account. One can think of it like a bank account. The main advantage of unallocated bullion is that it is cheaper to manage and trade and ownership can be transferred by book entries.
What are the legal consequences of these differences?
Since unallocated bullion is not an identifiable tangible asset, one cannot own it. An “owner” of unallocated bullion is therefore an unsecured creditor of the dealer, and should account for this accordingly. An owner of allocated bullion owns the bullion and should ensure that the asset is appropriately stored, cared for and insured.
How does a precious metal lease work?
Leasing is the name given to loans made in precious metal. Commercial end-users may “borrow” metal to be used in manufacturing jewellery, catalysts or in industrial processes. The loan is usually made by a spot sale of unallocated metal, in return for a reverse forward purchase of unallocated metal and the payment of interest denominated in metal, which may be cheaper than interest payable on a cash loan.