Spike in execution risk threatens futures infrastructure
By Andy Ross - CEO, CurveGlobal
It’s not all about the pandemic; but for futures markets participants, it is certainly increasing the stakes. Even before Covid-19 struck, the industry was tackling the complex challenge of transitioning from LIBOR to new risk-free reference rates (RFRs). The crisis has only reinforced the risks as we work towards the 2021 end-date.
In recent weeks, we’ve also seen the impact of increased volatility in the marketplace. It’s not just the jump in margin calls at some clearing houses, but we’ve seen growing liquidity and execution risk. Continued reliance on one dominant execution venue in each market exacerbates this. Placing all your eggs in one basket is yesterday’s game for an increasing number of traders – and it’s a big gamble for the remainder.
It’s time for institutional investors to make some smart decisions and ensure that they have a choice of at least two execution platforms, at any time, in any market. This simple approach to trading will reduce the reliance on historically siloed markets where there remains such a great dependency risk.
Not putting all trades through one venue is more than common sense – it’s business sense. While ensuring that you have continuous access to prices in the case of extreme markets or technology outages is perhaps obvious; in the case of derivatives, the inherent risk of an ‘ostrich policy’ is magnified by the dependence on one risk management and margining model.
Unlike some other CCPs, LCH hasn’t adjusted its risk model and continues to use volatility scaling to automatically adjust models in line with the market. However segregated assets held by US FCMs on behalf of clients, rose from $174bn at the end of February to $279bn at the end of March showing this model is not consistently applied. At LCH, not only does the firm have an industry-leading risk management policy, but it enables portfolio margining, across futures and swaps in multiple currencies delivering considerable netting efficiencies, regardless of where the execution took place.
By tapping into a venue, such as CurveGlobal, participants also get access to more than $100bn of member liquidity. So why haven’t some in the marketplace moved to a multi-venue approach? It’s hard to generalise but resource prioritisation and inertia are two common reasons given. While kicking the can down the road can work in stable markets that change little over the years, this is not the case today – and never will be again.
Markets are tightly interconnected in a way that was inconceivable when futures markets were developed for domestic purposes under the careful watch of domestic regulators. These also were the days when, for example, you could only find one sizeable domestic airline. In the UK, it was British Airways / British Midland in the days before Virgin Atlantic (1984), Ryanair (1985) and EasyJet (1995). These were the days before competition liberated travel for all, and this was the era when many domestic clearing houses took root.
In a post or even mid-pandemic world, restricting trading to just one venue is the type of risk that few other markets would even consider, certainly cash equities and fixed income, where competition is rife, both in the exchange and over-the-counter worlds.
Making smart business moves should be enough on its own, but there is also the fiduciary responsibility that banks have on behalf of their clients, and clients have for their investors. It’s clearly time for a change in thinking.
While I’m no airline CEO, CurveGlobal is playing a valued role in ‘opening up the skies’ during these challenging times. It’s now up to participants to seize the opportunity to take a step into the future.