In May 2021 LBMA responded to the UK Prudential Regulation Authority (PRA) consultation on Basel III. The response highlighted that the current proposals regarding the Net Stable Funding Ratio (NSFR) fail to take into account the damaging effect that the rules will have on the precious metals clearing and settlement system, potentially undermining the system completely, and on the increased costs of financing of precious metals production. In addition, the proposal fails to take account of the quantitative evidence, which suggests that in a liquidity crisis, gold acts as an extremely high-quality liquid asset.

In its policy statement published on Friday, 9 July 2021, the PRA recognised the argument in favour of providing precious metals clearing and settlement service but decided not to change its position on gold as a high-quality liquid asset (HQLA).

London Precious Metals Clearing Limited

The PRA’s policy statement, under paragraph 13.91, confirmed as follows:

“The PRA has considered the responses and decided to amend its approach to precious metal holdings related to deposit-taking and clearing activities. The PRA has introduced an interdependent precious metals permission for which firms may apply in respect of their own unencumbered physical precious metal stock and customer precious metal deposit accounts. When the permission is granted, firms would apply a 0% RSF factor to their unencumbered physical stock of precious metals, to the extent that it balances against customer deposits.”

LBMA understands that at a minimum, the clearing members of LPMCL can apply to the PRA for 0% Required Stable Funding (RSF) because their client deposit can be treated as an interdependent asset and liability. Thus, effectively exempting the clearing services from the 85% funding requirement. This recognition of interdependent asset and liability by the PRA is consistent with Basel III text.

This has been welcomed by LBMA, as it ensures that LPMCL can continue to support the market in providing a smooth and effective service.

LPMCL works as an administrator and ensures that counterparties can access the bullion market, particularly for those who do not have the ability to store physical gold. LPMCL serves clients including central banks, central counterparties (CCPs), other commercial banks, financial institutions and many varied non-bank market participants.

CCPs rely on the LPMCL system to manage precious metals collateral and the physical delivery of precious metals derivative contracts. Commercial banks rely on the LPMCL system for safe clearing and settlement of precious metals transactions. Non-bank market participants rely on the LPMCL system for short-term liquidity. With daily average cleared gold transactions alone of over US$30 billion, the LPMCL system is unique and indispensable.

However, the text under paragraph 13.91 does not limit the “interdependent precious metals permission” to just LPMCL members. Therefore, on the face of it, any bank that holds physical gold with a client liability on the other side for clearing purposes may also be able to rely on this. LBMA will be following up with the PRA to get further clarity on the intent and the requirements.

Gold as HQLA

The PRA’s policy paper, paragraph 12.28, confirmed as follows:

“The PRA considers that while gold is a commonly traded and held asset, including as a reserve asset by central banks, the PRA has not found sufficient evidence of its liquidity, risk characteristics, and price stability to warrant treatment as HQLA. The PRA also notes that the Basel III LCR standard does not include gold within HQLA.”

LBMA believes further engagement with the Basel Committee Banking Supervision (BCBS), other members of the BCBS, will be helpful in discussing the relevant data that was presented to the PRA in response to the consultation.

Other funding factors

Other funding factors in the UK version have been set in line with other jurisdictions. Secured precious metals financing dependent on whether the collateral is level 1 or 2 will be set at 0% or 5% RSF. Gross derivatives liabilities will also attract a 5% RSF. Within Europe, the EBA and BIS have published impact assessments for all Basel III rules on a semi-annual basis. At the end of this year, it will be possible to view all European bank exposure to NSFR for every asset class, including gold.

LBMA Efforts to Date

LBMA, alongside other relevant market stakeholders, has long been engaged in discussing the impact of Basel III with regulators and relevant national authorities. Discussions have covered the following issues:

  1. The first was the Liquidity Coverage Ratio (LCR). This rule would ensure that banks have an adequate stock of unencumbered HQLA that can be converted easily and immediately in private markets into cash to meet their liquidity needs for a 30-calendar day liquidity stress scenario. However, at the time the HQLA list was being discussed, the gold market did not have enough data to support gold’s position. Therefore in 2013, BCBS decided that gold would fall outside of the HQLA list.
  2. The second was the NSFR. Designed to limit overreliance on short-term wholesale funding and to encourage better assessment of funding risk across all on- and off-balance sheet items, NSFR aimed to promote funding stability in the market.

    LBMA’s initial response questioned the 85% RSF within the NSFR rules, and questioned why gold was not considered HQLA within the Liquidity Coverage Ratio (LCR) rules. Being designated as an HQLA would see the funding factor reduced to 50% or less, depending on what level the central bank and prudential regulators considered appropriate.

    Initially, lobbying efforts were directed to the European Banking Authority (EBA), the Prudential Regulatory Authority (PRA) in the UK as well as other relevant EU member states, as well as the BCBS. From these meetings and subsequent regulatory liquidity publications it transpired that central bank and prudential regulators could not measure risks for gold in the same way as other asset classes due to the lack of data in the Over-the-Counter market (OTC).

    Following a membership market review in 2015, it was agreed that LBMA would collect and disseminate trade data to provide transparency to the OTC market and use the data to build the case for gold as an HQLA. The first trade data emerged in 2018, which showed that when compared to other HQLA assets, gold performed as well as – if not better than – other level one and two asset classes.

What’s Happening Now?

United Kingdom

As outlined above, the UK PRA has consulted on the implementation of the Basel III standards and provided its position. The policy material in their policy statement, as published, is near final. The PRA does not intend to change the policy or make significant alterations to the text of the instruments before the making of the final policy material. The PRA expects to publish the final rule instruments in a subsequent Policy Statement, after HM Treasury has published the relevant Statutory Instrument (SI) to support the implementation. This policy is intended to take effect on 1 January 2022.

European Union

Following a request by LBMA to the European Commission, an assessment is being carried out by the European Banking Authority (EBA). The EBA shall assess whether it would be justified to reduce the NSFR for assets used for providing clearing and settlement services of precious metals or assets used for providing financing transactions of precious metals of a term of 180 days or less. The assessment will be published in November 2021.

Other Jurisdictions

Through the support of LBMA members, LBMA is exploring further lobbying efforts with other jurisdictions given that the data LBMA holds is new, and was not available when the policy decisions were made.