On April 9, the Commodity Futures Trading Commission (CFTC) Market Risk Advisory Committee (MRAC) held a public meeting. The meeting covered current topics including central counterparty risk (CCP) and governance, market structure developments explaining the consolidation of Futures Commission Merchants (FCMs), climate-related risk, and innovative and emerging technologies like artificial intelligence (AI), affecting the derivatives and related financial markets.
Below is a summary of the meeting prepared by Delta Strategy Group.
UPDATE FROM CCP RISK AND GOVERNANCE SUBCOMMITTEE
Recommendations on Derivatives Clearing Organization (DCO) Recovery and Resilience
- Alessandro Cocco, Vice President of the Financial Markets Group at the Federal Reserve Bank of Chicago, on detail at the U.S. Department of the Treasury
- Elizabeth King, Global Head of Clearing and Chief Regulatory Officer, Intercontinental Exchange
- Paolo Saguato, Associate Professor of Law, Antonin Scalia Law School, George Mason University
- Cantrell Dumas, Director of Derivatives Policy, Better Markets
Summary:
The group discussed recommendations to improve DCO resilience and ensure that regulator resources are best utilized to enhance market stability. It laid out five recommendations: supervisory stress testing of credit risk for DCOs on an annualized basis, operational stress testing on an annual basis, include reverse stress tests in supervisory stress tests, and making stress test results available to the public. The group recommended that all these stress tests, except the reverse stress testing, be done annually.
The group emphasized that regulatory tests should be coordinated to ensure that the strength of the tests is not undermined by there being multiple tests by different regulatory bodies conducted in rapid succession. The group also recommended the CFTC prioritize maintaining the ability to port customer accounts in the event of winddowns, and it noted Basel III could harm the willingness of clearinghouses to allow porting.
The group emphasized the need for the CFTC to coordinate with the International Organization of Securities Commissions’ (ISOCO’s) Principles for Financial Market Infrastructures, as CCPs operate on a global level.
UPDATE FROM FUTURE OF FINANCE SUBCOMMITTEE
Presentation of Subcommittee Work Plan on Artificial Intelligence in Financial Markets
- Gary Kalbaugh, Deputy General Counsel and Director, ING Financial Holdings
- The subcommittee is exploring recommendations for the CFTC on how it might improve its engagement with AI, both in its regulation and its use in markets. The group is considering whether the CFTC should require governance of AI usage or require oversight positions for firms using machine learning.
Discussion:
Purvi Maniar, FalconX: FalconX is supportive of a survey that will allow us to further engage in dialogue with our regulators. Ongoing dialogue with regulators will be useful for FalconX to provide use cases of emerging novel technology like AI to the Commission.
Stephen Berger, Citadel, LLC: Any regulatory measures can potentially affect various operational domains. It is imperative to exercise caution in evaluating the extent to which AI regulations will influence operations and which operation are deemed to be “AI”.
UPDATE FROM MARKET STRUCTURE SUBCOMMITTEE
Part One: FCM Concentration and Capacity Analysis
- Ashwini Panse, Intercontinental Exchange, Inc., Head of Risk Oversight for ICE Clear Netherlands, Chief Risk Officer for the North American Clearinghouses
- The workstream has observed a large decline in the total number of FCMs, primarily led by the exit of many independent FCMs who are neither duly registered as broker dealers nor affiliated with banks or bank holding companies. More strikingly, there has also been a steep decline in FCMs who hold customer funds intended for futures trading. Upon examination of firms doing cleared swap business, there have been observed exits and downsizing by some notable firms in recent years.
- Although healthy levels of capital help FCMs, Basel III has the potential to reduce further capacity in the FCM business. As the rates change for businesses, firms will be faced with decisions to cut costs and reallocate capital. Capital rules must incentivize clearing. The workstream recommends additional analysis to understand how FCM consolidation will be impacted by increased regulatory obligations.
Discussion:
The Committee voted to approve the workstream report.
Part Two: U.S. Treasury Cash-Futures Basis Trade Presentation
- Nathaniel Wuerffel, Head of Market Structure, Bank of New York Mellon
- The Treasury cash futures basis trade has garnered significant attention, with elevated Treasury activity driving concerns that the strategy has grown amongst leveraged fund managers. The basis trade supports the Treasury ecosystem by enhancing market liquidity and efficiency, lowering funding costs, and improving capital formation and optimization. The return in the basis trade is small, so leverage is used to increase returns. Stress on these trades therefore could present a potential financial stability risk if unwound on a large scale. Effectively managing these risks can reduce counterparty credit and market functioning risks and can improve financial stability.
Part Three: Block Implementation Workstream Update
- Biswarup Chatterjee, Managing Director and Head of Innovation for the Global Markets Division, Citigroup
- The workstream focuses on analyzing trade volumes across different block sizes and studying the composition of datasets used for block analysis to ensure appropriate classification of trade types. The analysis mirrors internal assessments conducted by two trading venues within the working group. Progress updates will be provided to the MRAC regularly.
Part Four: Post-Trade Risk Reduction Workstream Update
- Biswarup Chatterjee, Managing Director and Head of Innovation for the Global Markets Division, Citigroup
- The workstream is focused on observing the Post-Trade Risk Reduction (PTRR) processes. These exercises adhere to predetermined and transparent rules and operate on predetermined and published cycles. The group acknowledges the significance of Title 7 in Dodd-Frank and the corresponding CFTC regulations. The workstream aims to explore how PTRR activities can benefit from exemptions regarding clearing, self-trading, registration, and real-time public reporting while ensuring the safety and soundness principles outlined in Dodd-Frank, Title 7, and safety rules are not compromised. Additionally, the group plans to examine potential compensating controls and processes to address any concerns about non-compliance with Title 7 principles.
CLIMATE RELATED MARKET RISK
- Dale Lewis, Chief Executive Officer, Community Markets for Conservation
- It is important to work with communities of small-scale farmers to alleviate climate risk by combining agricultural value-added markets with carbon credits, recognizing the complexities and historical contexts of rural farming systems.
- Holly Pearen, Lead Counsel, Environmental Defense Fund
- Carbon credits provide an opportunity to meet the corporate demand for emission reductions. These purchases could make a significant contribution to providing the estimated $41 trillion needed to close the climate funding gap. The Voluntary Carbon Credit Guidance well-positions CFTC to detect and deter VCM fraud and increase market integrity.
- Jessica Garcia, Senior Policy Analyst for Climate Finance, Americans for Financial Reform Education Fund
- U.S. financial regulators must confront climate-related financial risks, particularly within voluntary carbon markets. Across federal agencies, there is a need for comprehensive regulation to tackle integrity issues such as leakage risk and the absence of social and environmental safeguards. Furthermore, collaboration with other governmental bodies and the private sector is needed to ensure transparency and integrity in carbon markets, with a focus on preventing fraud and misleading claims.