Solving the gold paradox
08 December 2020
Tradewind Markets, a DLT platform aiming to overhaul the settlement of precious metals, has recruited banking veterans, including J.P. Morgan’s global head collateral chief Michael Albanese, who see blockchain as a way to revitalise liquidity pools and provide new collateral options
Image: stock.adobe.com/edwardolive
During a gold rush, sell shovels, as the old saying goes. One company to take this idiom to heart is Tradewind Markets. Founded in 2016, Tradewind is on a mission to apply distributed ledger technology (DLT) to the precious metals industry and break through the bedrock of cumbersome, costly and time-consuming pain points that are preventing gold from shining in financial markets.
Since the financial crisis, commodities markets have failed to innovate in the same way as other markets by embracing new technologies, such as blockchain, which could allow them to circumvent stubborn practical issues of tracking, storing and trading physical assets. The market has lagged to such an extend that a paradox has emerged: gold, synonymous with the concept of a safe haven asset, does not qualify as a high-quality liquid asset (HQLA) due to a lack of market transparency and poor price discovery. It is permissible to be posted as initial margin for over-the-counter derivatives captured by the Uncleared Margin Rules (UMR) but few, if any, are able to make use of it in this regard. In the insurance sector, the terms of Solvency II also takes a dim view of firms holding gold.
To meet this challenge head-on, in 2018 Tradewind created a product suite called VaultChain (a trademarked product of Tradewind), built on R3’s Corda blockchain platform.
Tradewind’s platform, aims to facilitate enrich price discovery and market transparency in gold markets, and, crucially, uncouple an assets physical location with the ability to settle trades.
It promises to securely digitise vaulted precious metals for the first time, removing structural and frictional limitations from the physical gold market which until now required shipping the metal around the world between vault hubs at great expense in order to settle.
Tradewind was initially backed by a cross-section of the DLT, commodities and mining communities and has gained tens of millions of dollars in funding rounds led by members of those markets. However, it has since caught the attention of participants of other financial markets, including securities finance, where it offers a way to leverage physical gold as collateral and different forms of margin, which is in greater demand due to UMR and other regulatory frameworks.
By transforming the slow and expensive process of physical settlement into an instantaneous, digital one, gold could be a viable addition to a firm’s balance sheet of liquid assets and be used for a host of activities including being borrowed and lent like a securities or used to collateralise securities finance transactions.
The platform, Tradewind says, allows purchasers to own physical gold digitally and combines the simplicity of an exchange-traded fund or derivative with an assurance that investors can assume custody of their metal.
Among those who caught the glint of the possibilities the platform offers is former-J.P. Morgan managing director and global head of collateral management, Michael Albanese, who joined Tradewind as CEO in April 2019 after just over two decades in the traditional banking universe.
Before 2019, Albanese spent the prior 15 years with J.P. Morgan in several senior positions also including global head of securities clearance, and head of Japan Trustee business, overseeing the securities lending, repo, collateral management and derivatives trading for buy and sell-side clients.
At Tradewind, Albanese is reunited with Jose Maria, who has served as the platform’s head of client insights and operations since 2017. Maria also spent the previous 11 years at J.P. Morgan as executive director within the global clearing business division, which encompassed futures, options and over-the-counter clearing, and was overseen by Albanese between 2011 and 2016.
Other members of the management team include Didier Bloch, who spent just over a decade managing SunGard’s (now part of FIS) North East Coast IT infrastructure until 2012.
Since then, he served in a number of technology-focused roles before becoming Tradewind’s chief information security officer in 2018.
Elsewhere, former-BNY Mellon managing director, technology, Leon Shklar is now Tradewind’s chief technology officer, responsible for all aspects of the firm’s technology including architecture, infrastructure, business applications and innovation.
SFT speaks to Tradewind Markets’ CEO Michael Albanese to discover what drew the veteran banker to a take-on the challenge of reintroducing one of the world’s oldest asset classes back into the mainstream through DLT.
You have been with Tradewind for a year, how do commodities compare to securities?
My time spent with J.P. Morgan was focused on securities market infrastructure, specifically with how equities and bonds were traded, cleared, settled, and mobilised as collateral. I had a front-row seat during several market crises and was able to see firsthand what can happen when there is extreme stress on the system. That experience taught me to reexamine the fundamental questions the securities market poses to lenders: Do you have the collateral you think you have? Where is it? Do you have rights to it? Are your assets segregated?
What drew me to Tradewind was the discovery that this overhaul of infrastructure had not yet occurred in non-securities asset classes, such as commodities. Areas of the market system, such as trade settlement, still require physical shipments of gold. Additionally, different market centres require gold in different formats to be used for settlement or collateral purposes. For example, London, which is a major hub for physical gold trading, requires 400 troy ounce bars (roughly 12.5 kilograms) for settlement, but if you try to hedge your London position in New York, the market has traditionally required 100 oz bars. Financing between the various market centres lacks the ease, cost-effectiveness, and capital efficiency we are accustomed to in securities markets.
Additionally, there tends to be no single, central record of ownership. Purchasers of gold, for example, can own assets in a vault in New York and another in London; however, the purchaser will then have multiple, siloed books and records of their owned commodities-- as will their counterparties.
The most significant difference between securities and commodities lies within price discovery. In the gold market today, fixed prices are determined twice a day by a group of banks in London. Unlike securities markets, there is little historical data available on trade sizes, prices, and market depth. Unfortunately for these reasons, gold does not qualify as HQLA, despite its prominence in government, institutional and sovereign portfolios. This renders gold an unsuitable asset for many otherwise interested institutional portfolios and makes gold costly to hold on a balance sheet. Comparatively, the equities and securities markets are decades ahead of this problem, which given the history of securities markets, means that commodities markets have a blueprint to follow.
What attracted you to Tradewind’s solution to this problem?
I’ve known for a long time that it was costly, dangerous, and wasteful for one of the world’s largest markets to have a settlement system like the one I’ve described. Tradewind was originally founded on the idea of making it easier for retail clients to buy and sell gold by leveraging digitisation and blockchain. Our current platform is essentially the official book, record, and digital ownership record for any gold bought and sold in the Government of Canada’s programme.
The Government of Canada runs a sovereign mint, The Royal Canadian Mint, and gold vault with a large network of broker-dealers that trade gold and sell it to their customers. Through Tradewind’s platform, broker-dealers are assured that their ownership is officially registered on Tradewind’s ledger and the government recognises it as a record of good title.
Crucially, regardless of the physical format of that gold, the owner is assured of “good title.” Additionally, regardless of the size of the bar or amount of coins, the owner can embed their gold with supply chain information about where and how the gold was produced.
I knew Tradewind had the potential to solve a much bigger problem for institutional markets by using the same distributed ledger technology (DLT) solution.
How have commodities been allowed to fall behind? Is that changing now?
We know that everything is fine until it’s not fine, and what makes things not fine is when an unexpected market event occurs. In the securities markets, it was the collapse of Lehman Brothers and the eurozone crisis. However, the gold market has yet to have its “Lehman moment.”
The gold market came pretty close to one in March. As a result of the COVID-19-caused disruption, the gold market seized up. Suddenly, if you were an institution buying gold in London and needed to settle it in New York, you couldn’t find an airline willing to ship the bars across the Atlantic or a refinery able to melt the 400 troy ounce bars and recast them into 100 troy ounce bars. Airlines had curtailed flights and refineries had slowed activity.
As a result, the price of gold in New York skyrocketed about 7 percent, compared to London. This meant that banks lost money on their hedges. A sudden 7 percent swing in asset price will play havoc with the mark-to-market. That was a wake-up call. Surely, there must be a more stable, orderly, cost-effective way to improve settlement in a market as important as gold.
Now that the pandemic has revealed the issues with the gold settlement process, are there any more hurdles in your way?
There are more hurdles, but they are starting to erode as well. Even the best ideas in this space don’t get traction until three things happen. One, regulators need to start getting involved. Two, institutions need to start feeling pain. Three, large institutions need to get egg on their face for not being prepared for certain market events.
Taking those points in turn, there are efforts to set a new standard for gold, most recently exemplified by Bank of England’s FICC Market Standards Board’s working group for precious metals.
Secondly, some of the major banks booked hedging loses in their portfolios in March — that’s the second catalyst taken care of. Third, the London-New York settlement problem in March became a real problem for futures exchanges, where contracts had to be amended to change the definition of ‘good settlement’ to ensure settlement did not fail. In my experience, the combination of these three events is enough for a solution to gain traction.
Fast forward to today, what’s next for Tradewind?
Tradewind is now looking to take what we’ve achieved in the retail market — which is to prove you can enable transactions for gold to be used as collateral, you can meet the standards of an AAA-rated sovereign government to recognise your ledger as legal title, and you can transfer gold regardless of the physical format – to other markets by plugging our ledger into other vault locations in major trading centres.
London and New York are the main two, but we are also in conversations with locations in Asia. The aim is to stitch together a network of vaults globally which will allow us to unleash the interoperability of VaultChain to free up assets, unlock balance sheets, and create a more stable and orderly market infrastructure.
If you’re now able to track gold and discern where precious metals are ethically sourced, do you see gold being classified as an ESG-friendly asset?
This is absolutely possible when you have transparent information on hand regarding the provenance of the metal. We launched a new tool earlier this year, ORIGINS, which allows users to tag their gold with information that applies to environmental, social and governance standards.
We facilitated a trade recently where a Canadian bank sourced gold from a mine in which ownership records and information on where, when, how, and who produced that gold was embedded in the gold’s digital record.
Since the financial crisis, commodities markets have failed to innovate in the same way as other markets by embracing new technologies, such as blockchain, which could allow them to circumvent stubborn practical issues of tracking, storing and trading physical assets. The market has lagged to such an extend that a paradox has emerged: gold, synonymous with the concept of a safe haven asset, does not qualify as a high-quality liquid asset (HQLA) due to a lack of market transparency and poor price discovery. It is permissible to be posted as initial margin for over-the-counter derivatives captured by the Uncleared Margin Rules (UMR) but few, if any, are able to make use of it in this regard. In the insurance sector, the terms of Solvency II also takes a dim view of firms holding gold.
To meet this challenge head-on, in 2018 Tradewind created a product suite called VaultChain (a trademarked product of Tradewind), built on R3’s Corda blockchain platform.
Tradewind’s platform, aims to facilitate enrich price discovery and market transparency in gold markets, and, crucially, uncouple an assets physical location with the ability to settle trades.
It promises to securely digitise vaulted precious metals for the first time, removing structural and frictional limitations from the physical gold market which until now required shipping the metal around the world between vault hubs at great expense in order to settle.
Tradewind was initially backed by a cross-section of the DLT, commodities and mining communities and has gained tens of millions of dollars in funding rounds led by members of those markets. However, it has since caught the attention of participants of other financial markets, including securities finance, where it offers a way to leverage physical gold as collateral and different forms of margin, which is in greater demand due to UMR and other regulatory frameworks.
By transforming the slow and expensive process of physical settlement into an instantaneous, digital one, gold could be a viable addition to a firm’s balance sheet of liquid assets and be used for a host of activities including being borrowed and lent like a securities or used to collateralise securities finance transactions.
The platform, Tradewind says, allows purchasers to own physical gold digitally and combines the simplicity of an exchange-traded fund or derivative with an assurance that investors can assume custody of their metal.
Among those who caught the glint of the possibilities the platform offers is former-J.P. Morgan managing director and global head of collateral management, Michael Albanese, who joined Tradewind as CEO in April 2019 after just over two decades in the traditional banking universe.
Before 2019, Albanese spent the prior 15 years with J.P. Morgan in several senior positions also including global head of securities clearance, and head of Japan Trustee business, overseeing the securities lending, repo, collateral management and derivatives trading for buy and sell-side clients.
At Tradewind, Albanese is reunited with Jose Maria, who has served as the platform’s head of client insights and operations since 2017. Maria also spent the previous 11 years at J.P. Morgan as executive director within the global clearing business division, which encompassed futures, options and over-the-counter clearing, and was overseen by Albanese between 2011 and 2016.
Other members of the management team include Didier Bloch, who spent just over a decade managing SunGard’s (now part of FIS) North East Coast IT infrastructure until 2012.
Since then, he served in a number of technology-focused roles before becoming Tradewind’s chief information security officer in 2018.
Elsewhere, former-BNY Mellon managing director, technology, Leon Shklar is now Tradewind’s chief technology officer, responsible for all aspects of the firm’s technology including architecture, infrastructure, business applications and innovation.
SFT speaks to Tradewind Markets’ CEO Michael Albanese to discover what drew the veteran banker to a take-on the challenge of reintroducing one of the world’s oldest asset classes back into the mainstream through DLT.
You have been with Tradewind for a year, how do commodities compare to securities?
My time spent with J.P. Morgan was focused on securities market infrastructure, specifically with how equities and bonds were traded, cleared, settled, and mobilised as collateral. I had a front-row seat during several market crises and was able to see firsthand what can happen when there is extreme stress on the system. That experience taught me to reexamine the fundamental questions the securities market poses to lenders: Do you have the collateral you think you have? Where is it? Do you have rights to it? Are your assets segregated?
What drew me to Tradewind was the discovery that this overhaul of infrastructure had not yet occurred in non-securities asset classes, such as commodities. Areas of the market system, such as trade settlement, still require physical shipments of gold. Additionally, different market centres require gold in different formats to be used for settlement or collateral purposes. For example, London, which is a major hub for physical gold trading, requires 400 troy ounce bars (roughly 12.5 kilograms) for settlement, but if you try to hedge your London position in New York, the market has traditionally required 100 oz bars. Financing between the various market centres lacks the ease, cost-effectiveness, and capital efficiency we are accustomed to in securities markets.
Additionally, there tends to be no single, central record of ownership. Purchasers of gold, for example, can own assets in a vault in New York and another in London; however, the purchaser will then have multiple, siloed books and records of their owned commodities-- as will their counterparties.
The most significant difference between securities and commodities lies within price discovery. In the gold market today, fixed prices are determined twice a day by a group of banks in London. Unlike securities markets, there is little historical data available on trade sizes, prices, and market depth. Unfortunately for these reasons, gold does not qualify as HQLA, despite its prominence in government, institutional and sovereign portfolios. This renders gold an unsuitable asset for many otherwise interested institutional portfolios and makes gold costly to hold on a balance sheet. Comparatively, the equities and securities markets are decades ahead of this problem, which given the history of securities markets, means that commodities markets have a blueprint to follow.
What attracted you to Tradewind’s solution to this problem?
I’ve known for a long time that it was costly, dangerous, and wasteful for one of the world’s largest markets to have a settlement system like the one I’ve described. Tradewind was originally founded on the idea of making it easier for retail clients to buy and sell gold by leveraging digitisation and blockchain. Our current platform is essentially the official book, record, and digital ownership record for any gold bought and sold in the Government of Canada’s programme.
The Government of Canada runs a sovereign mint, The Royal Canadian Mint, and gold vault with a large network of broker-dealers that trade gold and sell it to their customers. Through Tradewind’s platform, broker-dealers are assured that their ownership is officially registered on Tradewind’s ledger and the government recognises it as a record of good title.
Crucially, regardless of the physical format of that gold, the owner is assured of “good title.” Additionally, regardless of the size of the bar or amount of coins, the owner can embed their gold with supply chain information about where and how the gold was produced.
I knew Tradewind had the potential to solve a much bigger problem for institutional markets by using the same distributed ledger technology (DLT) solution.
How have commodities been allowed to fall behind? Is that changing now?
We know that everything is fine until it’s not fine, and what makes things not fine is when an unexpected market event occurs. In the securities markets, it was the collapse of Lehman Brothers and the eurozone crisis. However, the gold market has yet to have its “Lehman moment.”
The gold market came pretty close to one in March. As a result of the COVID-19-caused disruption, the gold market seized up. Suddenly, if you were an institution buying gold in London and needed to settle it in New York, you couldn’t find an airline willing to ship the bars across the Atlantic or a refinery able to melt the 400 troy ounce bars and recast them into 100 troy ounce bars. Airlines had curtailed flights and refineries had slowed activity.
As a result, the price of gold in New York skyrocketed about 7 percent, compared to London. This meant that banks lost money on their hedges. A sudden 7 percent swing in asset price will play havoc with the mark-to-market. That was a wake-up call. Surely, there must be a more stable, orderly, cost-effective way to improve settlement in a market as important as gold.
Now that the pandemic has revealed the issues with the gold settlement process, are there any more hurdles in your way?
There are more hurdles, but they are starting to erode as well. Even the best ideas in this space don’t get traction until three things happen. One, regulators need to start getting involved. Two, institutions need to start feeling pain. Three, large institutions need to get egg on their face for not being prepared for certain market events.
Taking those points in turn, there are efforts to set a new standard for gold, most recently exemplified by Bank of England’s FICC Market Standards Board’s working group for precious metals.
Secondly, some of the major banks booked hedging loses in their portfolios in March — that’s the second catalyst taken care of. Third, the London-New York settlement problem in March became a real problem for futures exchanges, where contracts had to be amended to change the definition of ‘good settlement’ to ensure settlement did not fail. In my experience, the combination of these three events is enough for a solution to gain traction.
Fast forward to today, what’s next for Tradewind?
Tradewind is now looking to take what we’ve achieved in the retail market — which is to prove you can enable transactions for gold to be used as collateral, you can meet the standards of an AAA-rated sovereign government to recognise your ledger as legal title, and you can transfer gold regardless of the physical format – to other markets by plugging our ledger into other vault locations in major trading centres.
London and New York are the main two, but we are also in conversations with locations in Asia. The aim is to stitch together a network of vaults globally which will allow us to unleash the interoperability of VaultChain to free up assets, unlock balance sheets, and create a more stable and orderly market infrastructure.
If you’re now able to track gold and discern where precious metals are ethically sourced, do you see gold being classified as an ESG-friendly asset?
This is absolutely possible when you have transparent information on hand regarding the provenance of the metal. We launched a new tool earlier this year, ORIGINS, which allows users to tag their gold with information that applies to environmental, social and governance standards.
We facilitated a trade recently where a Canadian bank sourced gold from a mine in which ownership records and information on where, when, how, and who produced that gold was embedded in the gold’s digital record.
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