Margining practices and non-default loss arrangements are regulatory themes.
Margining practices, especially in times of high volatility, and non-default loss arrangements were highlighted as regulatory themes at a World Federation of Exchanges conference.
In early 2020 when the COVID-19 pandemic was starting to cause lockdowns across the world, there was a spike in market volatility and record volumes of listed derivatives trading which resulted in increases in both variation and initial margin, but clearinghouses generally worked as intended.
Summer Mersinger, commissioner at US regulator Commodity Futures Trading Commission, said the industry has been through a stress test over the last few years, but may now be starting another one, and margins have been sufficient, risk modelling has worked and there have not been defaults. She spoke on a panel, Regulatory Themes in Clearing, on 27 March at WFECLEAR: The WFE’s Clearing and Derivatives Conference 2023 in Johannesburg.
“CCPs get frustrated that clearing members are blaming them for collecting too much margin but end users think there is way too much margin in the system,” Mersinger added. “I feel that if they are both complaining, then maybe we are in a good place.”
However, getting through the stress test does not mean that the industry should just say everything is fine. As a result, one of the things the CFTC is looking at is whether different types of collateral could be accepted as margin.
[caption id="attachment_121608" align="alignright" width="150"] Summer Mersinger, CFTC[/caption]
“Although, even when additional types of collateral were acceptable for initial margin, most people were just gave cash as that is what clearing members preferred,” she added.
Anne Clayton, head of public policy and regulatory affairs at Johannesburg Stock Exchange, said on the panel that the margin process can be improved with education and increased transparency in how risk models work.
“We got through a really stressful period and CCPs were resilient.So, if it ain't broke, don’t fix it,” Clayton added.
Johannesburg Stock Exchange is taking an incremental approach to collateral so it takes cash and gold, and will add government bonds. She said: “I think recent events in the banking sector show that extreme reliance on a limited number of assets is not good.”
Astrid Ludin, deputy commissioner, Financial Sector Conduct Authority (FSCA) in South Africa, added on the panel that the CCP model in South Africa is a big concern because only a small, narrow asset class currently goes through the clearinghouse. She said the regulator is working towards mandated central clearing for over-the-counter derivatives, which it believes is very important for the safety of the market.
Mersinger added that the recent failures of US banks and the possibility of a large margin that is not completely secured overnight is a real concern. Some CCPs have access to accounts at the Federal Reserve Bank.
“There are a lot of non-designated CCPs that are trading in US dollars that might have a large margin call but do not have access to the Federal Reserve,” she added. “This is something we may have to address with Congress. “
Non-default loss management
Cyber security was highlighted as an example of an event, not related to a default, that could lead to a loss but is very hard to model.
Mersinger said: “I've just had an event where you know the heads of some of the largest CCPs were on a panel and they all said it doesn't matter how much money you throw at cybersecurity, it's a problem that you can't quantify.”
She continued that cybersecurity is something that regulators are going to have to think about because it is a huge vulnerability for every business.
Walt Lukken, president and chief executives of FIA, the derivatives trade organisation, said in a blog that the industry has a strong commitment to resilience, especially given the recent ION Markets cyber incident which prevented trades being reported to the CFTC, and extreme volatility caused by the failure of Silicon Valley Bank.
“The good news is our markets were made for such volatility,” he wrote. “Businesses immediately turned to the futures markets to hedge their risks. CME Group and Intercontinental Exchange both reported record volumes of trading.”
However, he said the industry needs to make sure it continually invests in technology and capacity to handle the massive flow of transactions. For example, the development of standards through efforts like the Derivatives Markets Institute for Standards (DMIST) will help ensure that every part of the trading process can be scaled up for the next waves of record volume.
Four of the largest exchanges – CME Group, Deutsche Boerse, London Stock Exchange Group, and Nasdaq – have formed partnerships with the technology companies that dominate cloud computing.
[caption id="attachment_77006" align="alignleft" width="150"] Walt Lukken, FIA[/caption]
“Their partnerships are based on the recognition that exchanges generate a vast amount of data, and moving that data to the cloud environment opens up tremendous potential for using artificial intelligence to mine that data for insights,” he added .
Lukken is also confident that the technology promise of digital assets will be realized sooner or later, but the focus right now is on practical use cases. For example, several firms in the industry are exploring ways to tokenize the movement of collateral.
“There are huge amounts of cash and securities moving through the clearing system every day, and anything that can take friction out of that process would have tremendous benefits,” he wrote. “In my view, these types of practical use cases will be the gamechanger that we have been discussing for several years.”