FIA's annual conference in Boca Raton provides a unique opportunity for taking stock of trends in the listed and cleared derivatives industry. This year's conference, held on March 15-17, was no exception.
For three days, thought leaders and deal makers from exchanges, clearinghouses, market makers, clearing firms, regulators and technology vendors discussed a wide range of topics related to the macro trends affecting the global derivatives markets, which just concluded another year of record-breaking volume.
Four themes dominated the discussion: the rapid growth of cryptocurrency markets and the potential for disruptive innovation; the invasion of Ukraine and the implications for global commodity markets; the short squeeze in the London Metal Exchange's nickel futures market that took place the week before the conference; and the growing importance of cloud computing and other forms of fintech to the trading and clearing ecosystem.
The conference also was notable for the return to an in-person meeting. Not since March of 2019 have people in the FIA community been able to come together at FIA Boca and engage in the kind of face-to-face discussions that have been the mainstay of this event for more than four decades.
Crypto: The new kids on the block
The rising prominence of the cryptocurrency sector was probably the hottest topic at this year's Boca. First, it was hard not to notice the large number of crypto companies with a high-profile presence at the event, including exchanges such as Coinbase and FTX, market makers such as B2C2, Cumberland, Jump Crypto, and other service providers such as BlockFi, Copper.co, Kaiko, Solidus and Talos. For many attendees, the presence of these companies was the most noticeable change from previous years, and it indicated the interest these companies have in attracting the attention of leading players in traditional markets.
For FTX, the Boca conference provided many opportunities to present its direct clearing model to the FIA community. FTX executives including its chief executive Sam Bankman-Fried fanned out across the conference, pitching their approach in numerous conversations with industry leaders and other market participants.
Second, the influx of crypto companies is raising new questions about market structure. In particular, one of these companies, FTX, is seeking to introduce a new model for clearing into the US futures market that could disrupt traditional market structures and change the role of intermediaries.
FTX currently runs a large crypto derivatives market offshore that uses a direct clearing model. Its customers are members of the FTX clearinghouse and post their own collateral to cover the margin requirements on their positions, rather than using intermediaries. Furthermore, trading and clearing operate on a 24/7 basis, margin requirements are recalculated every 30 seconds, and positions are automatically liquidated whenever there is a shortfall.
Last August FTX bought LedgerX, a company that operates a futures exchange and a clearinghouse regulated by the Commodity Futures Trading Commission. It is now seeking permission to import this direct clearing model into its US business. One week before the conference, the CFTC released a "request for comment" to gather feedback on this proposal. CFTC Chairman Rostin Behnam explained in his keynote speech at the conference that the proposal deserves "careful consideration" and said the agency will be "careful, patient, and deliberative with this request."
For FTX, the Boca conference provided many opportunities to present its direct clearing model to the FIA community. FTX executives including its chief executive Sam Bankman-Fried fanned out across the conference, pitching their approach in numerous conversations with industry leaders and other market participants.
The response was mixed, however. Some market making firms that have been active in FTX's offshore market commented positively on their experience with this model and noted that it has been tested by several bouts of high volatility in the crypto market. But other participants expressed strong reservations about the auto liquidation process and the risk that it could accelerate violent moves in the markets. They also expressed concern that the direct clearing model, once approved for crypto futures, would be extended to other markets. That might not work for customers using futures to hedge positions in the underlying financial or commodity markets—if the clearinghouse closed out their futures position through its auto liquidation process, their underlying position would not be hedged.
An equally important issue is the question of which branch of government should take the lead in regulating crypto. Although FTX opted to buy a futures exchange and therefore put itself under regulation by the CFTC, US policymakers have not yet determined how much of the market should be regulated by other regulators such as the Securities and Exchange Commission and the Federal Reserve. Dan Berkovitz, a former CFTC Commissioner who now works at the SEC as the agency's general counsel, highlighted this issue during a panel discussion, saying that crypto assets are a new type of product that cuts across "multiple agencies and multiple jurisdictions."
FIA President and CEO Walt Lukken addressed this issue in his opening remarks, saying that regulators should welcome innovation and analyze new models for clearing "through the lens of responsible innovation and fair competition." It is not for regulators to project their moral judgment on whether digital assets are good or bad for society, he said. They should focus instead on the core principles of what makes a healthy and safe environment.
"Markets are fair when all participants are treated the same for the activities they perform, the risks they generate or the products they trade," he said. "If an activity is generating risk, then it should be regulated and capitalized the same, no matter what you label the model."
LME: Nickel crisis casts a long shadow
The recent turmoil in the LME nickel market grabbed nearly as much attention during the three days of the conference as crypto, and in its own way raised similar questions about market structure and risk management.
On March 8, the week before the conference, LME decided to halt trading in nickel futures after an extraordinary surge in prices and cancel a large number of trades that had been executed that day. The nickel market remained closed for the rest of the week and into the following while one of the nickel market's largest participants, a Chinese steel maker with a very large short position, struggled to cover its margin requirements.
Although the situation at LME was not explicitly part of the conference program, LME's handling of the situation and the potential ramifications for the industry as a whole came up in numerous conversations among conference participants. Trading firms were especially critical of the exchange's cancellation of the trades. As one speaker noted during the opening panel discussion, LME's decision to cancel trades will prompt market participants to take a closer look at the rulebooks at other clearinghouses and determine if they have similar powers to bust trades.
"As far as I'm aware, it's the first time that bona fide trades matched on an exchange were cancelled after the fact," Dave Olsen, president and chief investment officer at Jump Trading, said during the conference's opening panel discussion. He noted, "It wasn't a technology malfunction. It wasn't a mis-hit. It was a buyer and seller agreeing on an exchange to make a transaction."
Another possible result is more pressure on LME members to provide the exchange with greater visibility into their off-exchange positions, and more pressure on the exchange to limit the concentration of on-exchange positions—both of which were factors in the short squeeze that disrupted the market.
Still another issue raised by the nickel crisis is whether trading might move to another exchange. Although this was not addressed on-stage, many participants discussed it privately on the sidelines of the conference. The Shanghai Futures Exchange already offers futures on nickel and that market is often cited as an important signal for price discovery, but for a variety of reasons industrial users in Europe and the US are unlikely to rely on that market to hedge their risks. Instead, traders are looking west, not east, to CME Group in the US. CME has long had a successful copper futures market, but until now has had limited success in other industrial metals. Several senior CME executives attended FIA Boca and several attendees commented that the LME situation came up during their conversations with the exchange.
Ukraine: Dislocation and relocation of commodity flows
Another hot topic at the conference was Russia's invasion of Ukraine and the impact on global markets. Both the war itself and the resulting sanctions on Russia have sharply curtailed supplies of key commodities such as oil, gas, nickel, aluminum, wheat and corn. This disruption has caused a sharp increase in prices of commodity futures as well as higher margin requirements, leading to financial difficulties not only for the Chinese steel maker at the core of the LME nickel crisis but also a wide range of commercial end-users in other markets.
On a longer term basis, the economic isolation of Russia is likely to lead to a major restructuring of global production and distribution of commodities, and that in turn will create new challenges and opportunities for exchanges, brokers and end-users. European leaders have announced their determination to drastically reduce Europe's reliance on Russian energy, and the US, already a major exporter of oil and gas, is poised to fill the gap.
Two keynote speakers—Mark Carney, a former governor of the Bank of England and the Bank of Canada, and Harold Hamm, the founder and chairman of Continental Resources—addressed this topic. Carney commented that Russia's invasion would have long-term repercussions on the world's geopolitical and economic alignments and predicted a move towards "geostrategic onshoring" in Europe and the US to reduce their economic reliance on countries that do not share their values. Hamm, who leads one of the largest natural gas producers in the US, spoke about the reorientation of the US gas sector towards export to Europe and Asia and the need for additional capital to finance further expansion.
Several speakers also addressed the potential impact on the global campaign to reduce climate change. One example of a short-term tradeoff of Russia's isolation: some power companies in Europe are switching from gas to coal, leading to higher emissions. But the speakers predicted that even if emissions rise in the short term, the drive to reduce the use of fossil fuels would intensify, leading to more investment in renewable fuels and carbon capture projects around the world. As Hamm commented, this must be a global effort because "we all breathe the same air."
Carney, who is now the UN Special Envoy for Climate Action and Finance, also spoke about the need for capital to finance the decarbonization of key sectors such as steel and cement production, power generation, and transportation. Several exchange leaders spoke at length about their role in supporting this transition. Trabue Bland, who oversees the futures exchanges operated by Intercontinental Exchange, noted that ICE runs several large and growing markets for emission allowances, a key element in the cap-and-trade mechanism for reducing emission allowances. Bland commented that this market has tremendous upside as the world moves more aggressively to limit carbon. As he put it, "the total addressable market" is the global economy.
Julie Winkler, chief commercial officer at CME, spoke about the exchange's recent introduction of carbon offset futures and noted that commercial firms have shown strong interest in using the contract. Peter Reitz, chief executive officer of the European Energy Exchange, added that his exchange's power futures are playing a key role in the financing of renewable energy projects by providing a way to lock in long-term prices for power.
Fintech: Exchanges in the Cloud
Cloud computing is hardly a new trend in capital markets, but this year's FIA Boca conference marked a new high point in the awareness of the major cloud providers. Amazon Web Services, Google Cloud and Microsoft, the big three in the cloud services market, were all present at the conference and eager to showcase their alliances with major players in the derivatives markets.
Last year, interest in the topic stepped up when CME announced a 10-year exclusive partnership with Google Cloud and Nasdaq began moving its matching engines to the AWS cloud. Now the focus is on the impact of this trend, sometimes called "infrastructure as a service." Senior executives including John Davidson of the OCC, Brad Levy of Symphony, Marc Murphy of Nasdaq, Jay Rajarathinam of TMX Group, and Ken Vroman of CME all spoke about the benefits of migrating core services to the cloud as well as their outreach to customers navigating the transition.
In a related trend, this year's conference attracted senior executives from venture capital and private equity firms with an interest in financial technology. They included the strategic investment arms of banks, exchanges and trading firms as well as independent firms such as Flexpoint Ford, which financed a management buyout of Dash Financial Technologies in 2018 and then sold its interest to Ion Investment Group in 2021; Illuminate Financial, which has made numerous early stage investments in fintech startups; and 7Ridge, a new firm that made headlines last year with the acquisition of Trading Technologies.
The conference also attracted advisers from investment banks such as Evercore, Moelis, Jefferies and Perella Weinberg that specialize in arranging mergers and acquisitions. Although these bankers typically keep a low profile at the conference, they work closely with the management teams at banks, exchanges and other firms in the capital markets arena, and the conference historically has been an ideal environment for building connections and making deals. The advances in the adoption of cloud computing, combined with the emergence of a new generation of cloud-native technology vendors and service providers, helped drive a wave of M&A deals in 2021, and judging by the number of investment bankers at this year's conference, 2022 is likely to see plenty more.
Another technology trend visible at FIA Boca came from FIA itself. On March 15 FIA released a progress report on the industry standards initiative that it launched in November. As described in the report, FIA is preparing to establish an independent body to be called the Derivatives Market Institute for Standards (DMIST) that will focus on developing standards for exchange-traded and cleared derivatives. FIA also has identified certain areas in the trading and clearing workflow that are in the greatest need of standardization, including allocations and give-up processing, average pricing, reconciliations, and static data. Third, and perhaps most important, FIA outlined an initial set of standards to improve the timing of trade allocations and give-ups.
Work on the standards initiative is being spearheaded by a taskforce comprised of experts from several leading clearing firms, clearinghouses and institutional investors, including Barclays, Cargill, Eurex Clearing, Intercontinental Exchange, J.P. Morgan, Macquarie Futures, Russell Investments, and Société Générale. The progress reflects their determination to improve the industry's operational efficiency and automate more of the trading and clearing workflow. The FIA Boca conference provided a platform not only for announcing the progress report but also discussing the initiative with a large number of industry vendors that are critical to the success of this standardization initiative.
"There's been tremendous interest in this initiative since the launch in November and we are anticipating that a wide range of firms will be represented in DMIST at launch," said Don Byron, senior vice president and the head of global industry operations and execution at FIA.
Back to Boca: Building trust and understanding
If there was any doubt about the value of in-person meetings, it vanished once people began to arrive at the conference. More than a thousand people attended, including almost 200 who came from outside the US. Meeting rooms and reception areas were jammed with industry executives reconnecting with colleagues and customers and catching up on the latest developments in the industry.
If there was any doubt about the value of in-person meetings, it vanished once people began to arrive at the conference. More than a thousand people attended, including almost 200 who came from outside the US.
The fact that the conference took place against a backdrop of war in Ukraine reinforced another value of in-person meetings. As Mark Carney and other speakers pointed out, the imposition of sanctions on Russia is the latest in a series of steps away from the globalization trend that brought different parts of the world closer together since the turn of the century. The trade wars between the US and China, the UK's decision to leave the European Union, and the rise of populist movements all have contributed to a "deglobalization trend" towards a less connected world and greater obstacles to the flow of capital across borders.
In this context, the conversations that took place during FIA Boca may help counter this trend. As CFTC Commissioner Dawn Stump commented during a breakfast with exchange leaders, market regulators may not always take the same approach to cross-border issues, but they need to have a foundation for cooperation. That requires trust and understanding, she said. Communicating through video platforms such as Zoom will continue to be necessary, she added, but face-to-face conversations are far more effective at building trust and understanding.
