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CFTC Global Markets Advisory Committee Meeting

Commodity Futures Trading Commission

Global Markets Advisory Committee Meeting

Monday, February 13, 2023

Topline

  • Three panels were held, focusing on Global Market Structure and Access to Markets, Global Commodity Markets Volatility, and Digital Assets Markets.
  • Commissioners voted to establish a Global Market Structure Subcommittee, a Technical Issues Subcommittee, and a Digital Asset Markets Subcommittee with unanimous votes.

Panel I: Global Market Structure and Access to Markets

State of the Financial Markets

Derek Kleinbauer, Global Head of Fixed Income & Equity e-Trading, Bloomberg and President, Bloomberg SEF LLC, discussed the recent heightened volatility in global markets. He cited the transition of the UK out of the EU, the spread of COVID-19, the Russian invasion of Ukraine, rising inflation and monetary responses by central banks, and the collapse of FTX as causes. Kleinbauer said these events led to the increased need for access to liquidity at a moment’s notice. He also discussed the increasing need for accessing electronic platforms, noting the benefits of e-trading include: pre-trade price discovery, increased access to liquidity sources, ease of execution, and straight through processing for post trade efficiency.

Kleinbauer discussed the recent and dramatic growth in the use of e-trading, explaining how clients seeking liquidity are moving away from traditional voice methods to execution platforms. He also noted the growth in e-trading adoption in the corporate bond space, and the rise in passive investment strategies. Kleinbauer said the increased adaption of portfolio trading and all-to-all trading represents an efficient and cost-effective alternative to traditional centralized trading models.

Kleinbauer discussed the increased activity in credit default swaps and interest rates swaps, noting that this increase is reflective of clients managing their interest rate exposure. He said swap execution facilities (SEF) were a destination post-Brexit, adding the implementation of SEFs has been a success. Kleinbauer added the SEF marketplace has adapted, performing well even in times of extreme volatility. He concluded by warning that SEC proposals must be proportional to execution methods.

Part I: Trading & Liquidity

Brad Tully, Global Co-Head of Corporate Derivatives and Private Side Marketing, J.P. Morgan, said

the Treasury market (TM) is the deepest and most liquid financial market in the world. He noted last year was challenging for TM liquidity, as market depth declined over 60%. Tully explained how this trend reflects the impact of the changing monetary policy environment and longer-term structural changes to the TM. He noted that automated trading has grown to 75% of TM trading, which enabled new trading and investment strategies.

Sachiyo Sakemi, Global Head of Legal for Global Markets Group, BlackRock, discussed BlackRock traders’ recent experiences with liquidity challenges. She said volatility is elevated across many asset classes, noting the willingness of dealers to warehouse risk has declined significantly. Sakemi said it is harder for end investors to move risk without causing market impact, adding that BlackRock is using block trades more. She admitted this approach is not scalable. Sakemi warned that collateral and margin requirements can lead to stress and called for better calibration and transparency for central counterparty clearing houses’ (CCP) margin practices. She also called for the expansion of eligible collateral for margins, the conservative sizing of IM requirements, and enhanced transparency of margin models. Sakemi recommended the careful consideration of the cumulative impact of bank capital requirements on market making capacity.

Vadim Zlotnikov, Head of Fidelity Institutional, Fidelity Investments, said the cumulative impact of the growing chorus of proposed and potential reforms could have deep ramifications. He maintained that while the broader use of central clearing of some repo agreements could result in increased transparency, central clearing must be principle based. Zlotnikov warned a one size fits all approach would be counterproductive. He said Fidelity doesn’t believe central clearing in Treasury cash markets is necessary.

Isaac Chang, Head of Central Execution, Global Fixed Income, Citadel, said we are going through a period of heightened macroeconomic volatility. He said there must be a broad cross section of market participants to realize the benefits of central clearing. Chang called for efficient access to central clearing, including indirectly through client clearing offerings. He also said we need to evaluate the SEC’s proposal to rewrite the definition of the term “dealer.” Chang concluded by affirming the importance of preserving international alignment of clearing and trading obligations in the swaps market as derivatives markets evolve.

Scott Fitzpatrick, CEO, TraditionSEF discussed challenges to be addressed concerning swap intermediation. He cited cross-border implications, information asymmetry across regulatory jurisdictions, and inconsistencies between SEFs and other similar trading venues.

Part II: Clearing

Gerald Corcoran, CEO and Chairman of the Board, R.J. O’Brien & Associates, discussed the impact of the maintenance margin requirement (MMR) on FCMs. He said the MMR reduces the return on capital to FCMs. Corcoran maintained that an ecosystem of FCMs is needed, noting there is a wide variety of customers requiring support. Corcoran said market volatility and higher MMR resulted in a massive repricing event in the FCM community. He asked if there should be a more surgical approach to margin requirements, and if there should be consistent requirements across exchanges for when there are volatile markets.

Agnes Koh, Chief Risk Officer, SGX Group, discussed how the change in regulatory capital has had an impact on the clearing of commodities over the past decade. She noted that multiple clearing members have limited their commodities derivatives business to only client clearing, explaining this could be due to Basel 3 standards. Koh said while there is a downtrend in the clearing of proprietary commodities, client commodities exposures have increased significantly.

Tetsuo Otashiro, Senior Head of Global Policy and Regulation, Japan Securities Clearing Corporation, noted that while it is difficult for U.S. customers to access exempt DCOs, U.S. customers can access “foreign futures” widely under the Part 30 regime. He added that US retail customers can easily access the foreign futures market, unlike U.S. swap customers who have limited access.

Erik Tim Müller, CEO, Eurex Clearing AG, said bank balance sheet constraints and the need for regulatory capital efficiencies will be the principal drivers of further shifts toward cleared repo markets. He added that uncleared margin rules have created unprecedented demand for liquidity management solutions, noting cleared repo markets help mitigate systemic risk and offer a diversity of market participants. Müller said excess liquidity will remain elevated in the Eurozone in 2023, and collateral scarcity in Europe will continue in 2023.

John W. Horkan, COO, LSEG Post Trade and LCH Group and Head of Americas, LCH, said risks to global financial stability have increased. He recommended CCPs be granted central bank deposit access in the jurisdictions they serve.

Part III: Trade Reporting

Chris Childs, Head of Repository and Derivatives Services, DTCC and CEO and President, DTCC Deriv/SERV, noted that while data quality is improving, we have more work to do to enable the amalgamation of data from multiple jurisdictions for the purpose of systemic risk oversight. He called for the adoption of CPM and IOSCO standards, adding that regulators must establish frameworks that allow for data amalgamation. He asked if this would be a standard global framework.

Steven Kennedy, Global Head of Public Policy, ISDA discussed the Digital Regulatory Reporting initiative, which he explained is about crowdsourcing and digitization. He said DRR turns trade reporting rules into machine-executable, open-access code. Kennedy said digitized fields can be used for submission to TRs, and DRR facilitates consistent implementation of the CPMI-IOSCO recommendations across multiple jurisdictions.

Panel 2: Global Commodity Markets Volatility

State of the Commodity Markets

Julie Winkler, Chief Commercial Officer of CME Group began Panel II by noting that energy prices remain elevated, but volatility has retreated. She noted that an already volatile environment for energy was exacerbated by the Russian invasion of Ukraine, when WTI prices increased over 60% from January to March highs. CME increased margin in several increments ahead of the invasion and throughout the first few weeks of the war, consistent with increased volatility, and Winkler said the provocative and measured increases resulted in only a single outright break. Winkler said that going forward, they expect 2023 to be a time for renewed focus on commodity risk management. She noted that China is expected to grow again, they are working through local stockpiles which will help increase demand for other commodities, Russia is still producing oil at pre-war levels, and there are weather risks as well. She concluded by noting that the industry looks forward to working with clients and regulators to navigate the risk going forward.

Part I: Market Fundamentals and End Users

Bill Bolton, CFO of Refining, Products, and Low Carbon Americas Trading and Shipping at bp began by highlighting that the company is seeking to provide the world affordable, secure, and low carbon energy, and noting that they will be a net zero company by 2050 or sooner. He said their focus is on buying, selling, and moving energy to integrate their products and services to provide solutions across the world. He also noted that by 2050, it can be expected that their shipping and trading business will be less carbon intensive. BP has increased the number of low carbon products they trade, optimize, and supply.

Finally, Bolton said the scale of disruption over the last year demonstrated the need to shift away from hydrocarbons in an orderly fashion. He said disruptions to the global energy supply and shortages caused by the Russian invasion will create important attention around the need to address all three elements of energy: security, affordability, and low carbon.

Joseph Nicosia, Gloval Trading Operations Officer and Head of Global Cotton Platform at Louis Dreyfus opened by explaining that disruptions cause market dislocations, which can lead to volatility and non-traditional price spreads over time. He noted that it is not just ocean or international freight that is affected by this, but also domestic logistic situations.

Nicosia said that since most agricultural products are grown in the interior of the U.S. but exported off the coast, coordination of trucks, chassis, containers, railroads, barges, ports, and ocean carriers is required. As we came out of COVID, however, import surges of containers into the U.S. forced capacity constraints, which resulted in huge backlogs at ports (130 to 160 ships were moored off the coast).

Next, Nicosia discussed the subsequent reliability problem, and the transpacific schedule reliability that affected everything from availability to cost and planning. Due to profitability, more and more containers left the U.S. empty than ever before. He highlighted several market risks and implications of supply chain issues, including that they create shortages of supply, basis levels are impacted, there is an increase in costs, long lead times are needed, there is a loss of sales, there are increased counterparty risks, and that geopolitical disruptions exacerbate supply chain problems. He concluded by noting that all of these end up impacting the consumer.

Thane Twiggs, Chief Compliance Officer at Cargill Risk Management stated that commodity markets impact a lot of people who may never know that they are involved. He cited a number of factors for recent disruptions, including COVID and geopolitical strife. He also mentioned another aspect of this issue, which is the impact of markets on the global food crisis. Twiggs reminded the committee the direct impacts of markets and moving commodities are global citizens.

Part II: Market Disruptions

Stuart Williams, the COO of ICE, began by noting that the reopening of the global economy after COVID would have been enough to make markets work hard, but now there is also a war in Europe where the aggressor is the main energy supplier to Europe. Additionally, central banks began pulling back a decade of loose monetary policy, so there we many factors to the significant disruptions from the past year.

Williams continued by noting that they have built a robust system since the 2008 financial crisis, which largely stood very well. The freight market doubled in price over the course of 2022, coal saw a resurgence, and natural gas went up tenfold from the middle of 2021 through the end of 2022. He said that prices have come down since then, however, largely driven by unseasonably warm weather, storage capacity being filled to unseasonably high levels, and renewables from hydro and wind.

Finally, Williams discussed where GMAC should be focusing. His first encouragement was to not legislate for the sake of doing so. As an example, he noted that the implementation of a price cap in Europe has been unhelpful, and he does not see that policy having any positive impact on the market. Second, he mentioned advocating for a global regulators system that is coherent across jurisdiction, with deference to local authorities where it makes sense. Finally, Williams mentioned thoughtful implementation of a switch away from a hydrocarbon intensive economy.

John Murphy, Global Head of the Futures Division at Mizuho America, discussed the impact on Nickel. He noted that there was an unprecedented price hike of 250% in one day of trading. Had the prices been allowed to stand on that trading day, he continued, Nickel would have faced a margin call 10 times higher than previous record level. Additionally, at least seven clearing members would have gone into default.

Murphy continued by explaining that these events were the direct result of the Russian invasion of Ukraine. He said the combination of energy trade with Nickel trade pushed volatility to unsustainable levels, putting clearing members and exchanges at risk.  Finally, he said this pushed the overall usage of capital significantly higher, forcing traders off the exchanges into OTC, which is something to avoid. He concluded by stating that as issues continue to grow geopolitically, it will be important have to keep our eyes on the ball as it pertains to all markets.

Jacqueline Mesa, COO and SVP of Global Policy at FIA, noted that a lot of products experienced extreme volatility. On March 3, there were large price increases across all metals and increases in margin calls. In Nickel, she highlighted large exposed short positions, more buying to hedge risks, and further pushing prices up and increasing margin. Mesa added that the price of Nickel increased 270% over three days, and due to the threat of numerous defaults, LME suspended trading for a week starting March 8 and canceled 3.9 billion in trades.

After this incident, Mesa noted, Oliver Wyman did an independent review and identified over thirty recommendations. Mesa highlighted five:

  • Monitoring and addressing risks in the OTC market;
  • Setting position/accountability limits tailored to the market/product;
  • Putting in place volatility controls to slow down extreme price movements (circuit breakers);
  • Rehearsing default management, such as orderly closing out positions; and
  • Providing a clear vision for how LME will respond to events and rebuild liquidity.

Finally, Mesa said that volatility controls could be further examined. She said the benefits include reducing and constraining price movements in a trading day perceived not to be reflective of markets. FIA has looked at volatility controls across exchanges, but it is hard to come up with best practices because there are different controls. She concluded by noting that it is important to think about the right controls, when are they triggered, and how long should they be in place.

Mike Golding, Transatlantic COO at Optiver, discussed the three main goals of exchange price controls, which include making sure a malfunction does not have ripple effects, making sure the market functions and disorderly trading does not continue with legitimate movements, and minimizing unneeded liquidations. He also included a summary of the different price controls (dynamic circuit breakers, circuit breakers, price limits, no limits), and concluded by noting that when considering an instrument, it would be naïve not to consider derivates.

The Global Market Structure Subcommittee and the Technical Issues Subcommittee were approved unanimously.

Panel 3: Digital Asset Markets

State of the Digital Asset Markets

Chris Zuehlke, Partner and Global Head of Cumberland, DRW, provided a brief view into the current state of the crypto asset market. He said the market is currently focused on three primary areas: risk management, stablecoins, and the evolving liquidity landscape. On stablecoins, he noted that with increased attention on their utility as a payment mechanism, more and more organizations are considering issuing their own. Additionally, he explained that there have been dramatic lending market changes, and liquidity concentration has become a concern.

On spot exchanges, Zuehlke explained that in the post-FTX world, there has been a slight uptick in the market share of U.S.-exchanges, but the leading exchanges are still non-U.S. There is also greater diversity in products traded offshore, including prime brokerage, custody, staking, education, borrowing, direct deposit, and NFT services. He also mentioned that post FTX there has been a move away from exchanges and directly to OTC marketplaces.

In the futures space, the story is very similar to spots. The U.S. market is much smaller than global futures markets, and Binance is the overwhelming majority of the liquidity (as is the case with spots). The products, leverage, margining systems, and liquidity protocols are the main reasons he believes that offshore markets are so popular, but he also noted that the U.S. is well positioned to grow its market share in derivatives.

Finally, Zuehlke discussed decentralized exchanges, which he described as pure innovation associated with the defi space. He pointed out that DEX volumes accounted for 15-20% of total spot volumes at peak in 2021, but now are -6% post-FTX. Uniswap remains the largest player by market share. Overall, he concluded, they are too powerful to ignore for an industry in search of certainty, innovation, and regulations.

Part I: International Policy and Regulation

Adam Farkas, CEO of the Global Financial Markets Association (GFMA), provided an overview of the regulatory landscape. He began by noting that there are many initiatives already in place globally to try to tackle the issue of how regulators should react to the innovation and development of various digital assets. He said they are advancing work in global regulatory and supervisory frameworks. In particular, he highlighted consultation to enhance cross-border payment where digital assets have an increasing role. Additionally, he said that there is a clear focus by global regulators and standard setting bodies trying to address the question of how to deal with the stream of innovation in the digital asset space.

The question is what industry could contribute to this. Farkas noted that GFMA is trying to facilitate the process by developing a classification of digital assets to support responses with industry input to define and classify different digital assets. In doing the classification, Farkas said they realized that some assets already fit into existing classifications, while others need a new tailored approach.

He concluded with three main messages:

  • Given the cross-border nature of digital assets, the importance of global coordination could not be greater.
  • Because of the intensity of innovation, close coordination between industry and regulators is needed.
  • At the global/international level, a taxonomy of/trying to group these assets will be essential.

Part II: Use Cases

Digital Finance and Tokenization

Michael Demissie, Head of Advanced Solutions, BNY Mellon, said this is a defining moment for digital assets. He added that digital assets can be viewed within three lenses: cryptocurrencies, digital cash, and tokenized assets. Demissie said his clients see cryptocurrencies as investable assets not currencies, noting that tokenized assets are going to be the bigger prize. He emphasized the importance of understanding how this space is going to evolve. Demissie admitted there is a bad actor situation and called for the restoration of investor confidence. He said it’s important to embrace innovation while maintaining trust and emphasized the importance of technology neutrality for the distributed ledger technology. Demissie concluded by calling for a taxonomy that distinguishes cryptocurrencies and crypto assets from traditional financial instruments.

Jason Chlipala, COO, Stellar Development Foundation, discussed Stellar Aid Assist, a first of its kind disbursement system powered by the Stellar blockchain network. He said Stellar Aid Assist enables the delivery of urgently needed cash assistance to vulnerable and displaced populations quickly and transparently. Chlipala said he hopes Stellar Aid Assist is a useful example of a non-speculative use for blockchain.

Non-Financial Activities and Web3

Christopher R. Perkins, President, CoinFund, noted U.S. crypto market participants still lack access to comprehensive regulated markets. He said creators and players can own assets in Web3, adding that NFTs are the most successful consumer product since the introduction of the mobile phone. Perkins said Web3 infrastructure for AI could introduce open-source development, community ownership, and governance. He concluded by noting that blockchain technology unlocks new ways to identify carbon credits.

Blockchain Technology

Mary-Catherine Lader, COO, Uniswap Labs said her company is excited about the opportunity for decentralized protocols to support the development of digital assets. She explained how blockchains combine data storage with money movement, which lowers costs by removing friction and operational overhead. Lader noted that blockchains can be open or closed, adding that open systems allow for interoperability, improved security, and transparency. She said decentralized protocols have 100,000+ participants providing liquidity in a range of sizes, and that she is excited to work on this with central banks. Lader emphasized the importance of distinguishing beneficial blockchain applications from hacks, scams, and bad behavior. She concluded by calling for the encouragement of public-private sector collaboration on De-Fi.

Open Discussion & Vote

Perianne Boring, CEO, Chamber of Digital Commerce, said she wants to address how the lack of regulatory clarity around digital assets impacts her members. She noted that there is an incredible depth and breadth to the blockchain technology industry, adding the SEC has not proposed or adopted any rules that provide a clear path to successful registration. Boring said the Biden Administration’s statements seem to suggest the answer is to wait for Congress to enact legislation. She encouraged the Administration to collaborate and coordinate with stakeholders to bring regulatory clarity to the market and address regulatory patchwork, emphasizing the consequences of this patchwork can’t be overstated.

The Digital Asset Markets Subcommittee was established on a unanimous vote.

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