A Guide to the Loco London Precious Metals Market
8. Precious Metal Accounts
The Metal not the Account
Clearly, gold, silver, platinum and palladium are all traded metals. It is an important distinction that it is not unallocated or allocated metal that is traded, but the metal itself. The allocated and unallocated terminology simply reflects the type of account over which the metal clears post trading.
Unallocated Accounts
Probably in excess of 90% of all precious metals traded on the interbank/wholesale/OTC market clear over unallocated Loco London accounts. Ultimately, this reflects a debit or credit over an account, and the account holder has a contractual claim against the clearer – rather than a specific bar. Therefore, a credit balance on an account means that the owner of the metal has credit exposure to the institution where the account is held. In this respect, it is analogous to a current/checking account held with a bank for a currency.
The advantage of settling precious metals over unallocated accounts is that it is quick, simple and a specific quantity of metal can be bought (or sold). For example, if an investor wishes to purchase $1,000,000 worth of gold then this number could simply be divided by the spot price and the relevant amount of metal, calculated to three decimal places, could be credited to the unallocated account on the spot date with the US dollars also being paid on that day.
For investors that are used to transacting in the global foreign exchange market, this type of transaction is very familiar.
Allocated Accounts
Unlike unallocated accounts, an allocated account is backed by a specific bar of the precious metal. So that the investor would not see a simple credit on their account but instead a weight list of bars, plates or ingots showing the unique bar, plate or ingot number, gross weight, the assay or fineness of each bar, plate and ingot – and in the case of gold, its fine weight.
Credits or debits to the holding will be effected by physical movements of bars, plates or ingots to or from the client’s physical holding. An allocated account cannot, by definition, be overdrawn.
In this instance, the investor does not have a credit exposure to the institution where the account is maintained and, in the event that the account operator is declared in default, then theoretically the creditor could simply drive to the vault and remove their bars physically – in practice this would be rather more complicated given that these facilities are very high security environments that do not welcome visitors. In this respect, it is analogous to a safe deposit box with the account operator simply acting as custodian.
When discussing the difference between these two types of account and particularly their credit profile, a common question is “why would anyone ever trade unallocated metal given the very different credit profile of each?” The answer is equally straightforward. Convenience.
Silver bars
For example, an investor looking to get exposure to precious metals would have to buy gold in approximate multiples of 400 ounces, silver in multiples of 1,000 ounces, and platinum and palladium 1-6 kilograms – these being the sizes of the Good Delivery bars which would exclusively be held in such facilities. A further complication is that a standard ‘400 ounce gold bar’ can weigh between 350 and 430 ounces, and will have a minimum purity of 995 (so called ‘two nines five’) or 99.5%.
So even if the seller manages to source a bar weighing exactly the 400 ounces that the investor required, they would be charged for the gross weight multiplied by the purity. For example, 400 x 0.995 = 398 ounces. Please see section 7 for more information regarding the weighing of bars.
Ultimately, any requirement to trade allocated metal is likely to be a two-stage process. The investor would initially purchase a quantity approximately divisible by 400 ounces, in the case of gold. This would then need to be adjusted later in the trading day to the specific quantity of gold contained in the allocated bars. Clearly, this can be both over and under the requested quantity – although most vault operators will endeavour to get as close to the required amount as possible.
For example, an investor wants to buy 10,000 ounces of gold and is actually allocated 9,993.213 ounces of fine gold. The investor would then need to sell 6.787 ounces (being 10,000 – 9,993.213) back to the market maker from which the gold had originally been purchased and at the prevailing market price. Alternatively, if the respective numbers were 10,000 and 10,012.345 then the investor would need to buy the additional 12.345 ounces. Clearly, this is possible for occasional trades, but if an institution is transacting hundreds of precious metal trades a day, it is not feasible both in terms of dedicating specific bars for each transaction as well as the myriad of small balancing trades required. However, as per the below, it is possible to switch account balances from unallocated to allocated and vice versa.
Unallocated versus Allocated
It is worth noting that if an investor purchases metal and places it in an unallocated account then this amount can be switched to an allocated account, or vice versa – should conditions/requirements change.
Generally, members of London Precious Metals Clearing Limited (LPMCL) would look to achieve this switch no later than on the spot date and, in most instances, on the day that the instruction is received. However, this can vary depending on market circumstances. Whether or not there is a charge for this service will once more depend on the individual clearer.
Charges
Investors will have to pay a maintenance fee for their unallocated account or a storage fee for their allocated account. Charges will vary between account operators.
Traditionally, a fee was levied on the basis of the number of bars held, with no reference to the underlying price of the metal. However, more recently, charges have tended to be calculated as a certain number of basis points on the value of metal in the account. This is assessed daily and charged quarterly in arrears.
For example, if the levy was 25 basis points on an account containing 10,000 ounces of gold, where the spot price of the metal was $1200 per ounce, then the charge for that particular day would be:
((10,000 x $1200 x 0.25%)/360) x 1 = $83.33
Given the lower value of silver compared to the other precious metals, the storage costs tend to be commensurately greater, while platinum and palladium storage fees tend to be higher than those for gold, but lower than those for silver. Fees will vary between clearers and as to whether the metal stored is in London or Zurich.
As has been mentioned earlier in this Guide, London is the dominant clearing centre for gold and silver, but the picture is more nuanced for platinum and palladium, with Zurich still playing an important role.
However, it is worth highlighting some important differences between the two centres. London has more clearing members and the Aurum electronic matching system operated by LPMCL is at its heart. Crucially, LPMCL provides the rules and structure to create an orderly market to settle Loco London transactions, all covered by Her Majesty’s Revenue & Customs Terminal Market Order (HMRC TMO). HMRC considers Full Members of the LBMA as official members of the market that can therefore trade under the terms of the TMO (please refer to section 17 for further details).
In London, switching between unallocated and allocated account, as noted above, is generally easy and flexible. However, in Zurich there are fewer clearers, no matching system and Swiss VAT rules make allocations more challenging outside of bonded warehouses.
Insurance
The owner of allocated metal is, in the absence of express contrary agreement with the institution where the allocated account is maintained, responsible for arranging their own insurance.