Spot gold exchange: What it means for you

When set up, the exchange will usher in more efficient, fair and transparent price discovery

The Finance Minister took the country one step closer to a nation-wide exchange for trading in physical gold this February, when he announced that a gold spot exchange would soon be established. While there have been no further announcements from the Centre regarding this, many stakeholders have begun doing the ground work.

Leading commodity exchanges are seriously working on the roadmap to take this idea forward. The World Gold Council is also pitching in to help roll out the exchange.

There is no doubt that this will be beneficial to gold consumers, but implementation could take a while as the country does not have the necessary infrastructure to handle delivery and assaying of physical gold. Regulatory issues could also play spoilsport.

What will change?

Currently, the supply of gold comes primarily from imports and recycled gold. Imported gold is gold bought by dealers who supply it to manufacturers, jewellers, retailers and financial institutions. Gold recycling takes place between the consumer and the jeweller. Once an exchange is established, the buyers and sellers of gold can transact on the exchange platform. Besides the actual users, the exchange will also attract traders and other institutional participants such as banks and funds, thus ensuring a higher level of liquidity.

The main benefit from this exchange will be more efficient, fair and transparent price discovery. The spot price of gold in India is currently decided by the Indian Bullion and Jewellers Association (IBJA). The members of this association are the biggest gold dealers in the country. The IBJA gets buy and sell quotes from 10 of its biggest dealers, averages these quotes, and adjusts for taxes to arrive at the spot prices.

Since most of the gold consumed in the country is imported, the dealers use the international gold price as the base, translate this price in rupee terms, add tax and pad the price further to add their commission to arrive at their quote.

But as the London gold fix scandal in 2013 revealed, such ad-hoc methods of price fixing are open to misuse. An electronic platform can display all the buy and sell orders in a transparent manner, thus acting as a check.

Another reason why consumers should welcome gold spot exchanges is because it will unify the country into one market with a single nation-wide price for each category of gold.

Currently, there are great variations in the prices of gold across the country. A study by WGC reveals that the difference between the highest and lowest spot gold prices in the metros could be higher than ₹2,500.

The third benefit for consumers will arise from standardisation and better quality assurance from gold spot exchanges. Gold traded on the exchange platform will be of specific standards prescribed by the regulator — it could be hallmarked by BIS (Bureau of Indian Standards) or certified by LBMA (London Bullion Market) or by assaying centres set up by exchanges. This will help build trust in the physical gold traded on the exchange, that is currently lacking in Indian spot gold market.

Implementation

The easiest way to take this idea forward would be to allow commodity exchanges such as the MCX to set up a subsidiary or a joint venture to operate a gold spot exchange.

Since the exchange is already enabling physical delivery of gold futures, it has delivery centres in Ahmedabad, New Delhi and Mumbai. While additional vaults will be required across the country, the exchange has the skillset to take this forward.

The country, however, lacks assaying centres for gold, since currently gold futures are settled using the gold already stored in government vaults, and hence, is of the highest quality. If retail consumers are to be allowed to trade their gold jewellery or coins on the exchange, there would have to be assaying centres all over the country, to certify this gold, convert it in to a tradeable quantity (maybe 8 g, 50 g, 100 g and 1 kg) and form (the gold might have to be melted or dematerialised before it is traded). This could take some time.

As far as regulation goes, the question that needs to be answered is: who will regulate a gold spot exchange? While the Securities and Exchange Board of India regulates commodity derivatives, it does not have the mandate to regulate spot commodity market.

Spot markets in agri commodities fall under the State list of the constitution and are regulated by State governments, but stock and future exchanges fall in the Union list. Investor protection, on the other hand, does not fall in either of these lists. So SEBI could be asked to regulate this exchange.

Once the regulator is identified, the rules and guidelines governing exchanges, clearing corporations, delivery and settlement mechanism, products, trading hours, and so on, will have to be decided upon. While it appears to be a long-winded road to a gold spot exchange, the country could benefit greatly by it. If all the gold held by Indian households is brought into circulation and freely traded, it can help reduce the current account deficit that is being marred by gold imports.

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