* LME gold and silver contracts to launch in second quarter
* Sources see contracts as inflexible and costly
* LME faces struggle to compete with New York, Shanghai futures
By Peter Hobson and Pratima Desai
LONDON, Jan 23 (Reuters) - Fears of inflexibility and rising costs are sapping enthusiasm for the London Metal Exchange's new suite of gold contracts, potentially leaving the exchange reliant on the threat of an increasing regulatory burden to drive uptake.
London's $5 trillion-a-year gold trade has, along with the rest of the City of London, found itself under increased scrutiny since the Libor scandal, with U.S. lawsuits alleging rigging against the banks that set bullion prices.
Regulatory pressure sparked the fall of the near century-old telephone-based gold fix, or benchmark pricing, which was replaced by an electronic alternative in 2015, and reform of the management structure of the London Bullion Market Association.
The LME, owned by Hong Kong Exchanges and Clearing Ltd (HKEx), says its contracts, which include spot, futures and options, would bring price-setting out of the back rooms of banks by creating a published forward pricing curve for gold and sliver out to five years.
It also says the contracts' central clearing would free the banks and brokers that dominate London's over-the-counter (OTC) gold market from increasingly onerous capital requirements, creating savings that could be passed to others in the industry.
But a source at a major gold trading bank said: "There's a lot of caution and probably outright scepticism from market participants whether this will add anything but another cost to the bottom line."
"In the OTC market there are no fees, you call somebody for a quote and you trade it," a source at a metals broker said.
The LME hasn't detailed the fees for trading and clearing using LME Clear, but said it is "confident that fee levels will be competitive".
Scepticism runs deep, however. Metal industry sources cite other failed attempts by the LME to establish new contracts including those for cobalt, molybdenum, plastics and aluminium premiums.
"CRITICAL MASS"
"This set of contracts was never intended to replace or undermine the OTC market." said Robin Martin, head of market infrastructure at the World Gold Council, an industry body that worked with the LME to design the contracts.
He said he expected most of the volume on the contracts to come from hedging between banks and brokers - which he said accounts for up to 90 percent of trading in the London market.
These could continue to agree trades bilaterally as under the OTC model, and then clear them on the exchange, enabling savings that would reduce costs for all the industry, he said.