Day 2 of FIA Expo is complete, and it was another good one.
Second days of conferences are typically less-attended, I would guess for the following reasons:
- People get their meetings done early and catch flights back home
- They can’t afford to be out of the office that long
- Day 1 party takes a toll
While I did hear a few murmurs from people over lunch that brokers had them out at 2am drinking whiskey, generally speaking it felt like another full house.
I of course managed to leave the CME party well before it ended and got a decent night sleep, which allowed me to attend much of day 2. Without having taken great notes, here is what I can remember of day 2.
PANEL 1: Clearing Leaders
John Dabbs of Credit Suisse chaired a panel consisting of:
- Thomas Book, Eurex
- Dan McGuire, LCH
- Michael McClain, OCC
- Trevor Spanner, LME
- Paul Swann, ICE
- Kim Taylor, CME
The most memorable discussion revolved around standards for margining and costs of clearing. We at Clarus are very familiar with the details of the margin calculations, but I have to admit I didn’t appreciate some of the issues starting to impact the calculations and standards for these computations.
The discussion focused on ESMA moving from a 1 day futures holding period to a 2 day holding period. Kim rightly pointed out that appropriate risk management is not just a margin calculation, so it is inappropriate to prescribe standards on just one or two components of risk management. Other than the margin calc itself, she mentioned things like sizing of the guarantee fund, treatment of collateral (eg 39.33), residual interest, frequency of variation margin runs, and segregation rules / customer gross margin. She’s right, risk management is a balance of all of the components.
She mentioned that during the MFGlobal days, they processed a default at CME where the designation was made at 3am, and the entire account was unwound by 8:30am; so 1 day is plenty long.
She also took the opportunity to slam the proposed rule 39.33, reiterating how crazy it is that FCMs would effectively need to transform US Treasuries into cash.
While I absolutely agree with her, I also look at it from the regulatory side, and can fully understand their concern. Regulators have successfully shifted much of the counterparty risk of the market into CCP’s, and they rightly want to make sure the CCP’s manage this effectively. It’s like if I put all my bars of gold into the basement. I’d want to make sure I got a good lock on the door. The only difference in my analogy, is that CCP’s are by nature professional risk managers. My basement is not naturally a vault.
While I find the topic very interesting, I’m sure some balance of regulatory arbitrage and appropriate risk management will be found and will be tweaked over years to come.
The other large topic was on customer segregation. It’s easy to get sold on the Eurex approach, full seg, full portability, etc, etc. Thomas walked us all through that and was challenged by Michael and Kim, particularly around costs (to both FCM’s and clients) in this model. Thomas’s response was that in Europe, they will be able to offer different levels, depending upon the appetite of the client. Mike said that the OCC introduced full seg many years ago (I hadn’t known that) and some clients preferred the services they received from the FCM back in the gross model.
The final topic was future developments. OCC touted their upcoming volatility products (hasn’t this been in the works for years?), LME mentioned using warrants as collateral (did I hear that right?), ICE is looking at clearing options and tranches, and mentioned their portfolio margining of single names with indices. Thomas mentioned their sec lending clearing, which I had heard of but he described it well, making us believe this one of the largest areas remaining in counterparty risk. Lastly Kim mentioned their portfolio margining, allocation workflow for OTC to match futures (clear then allocate), deliverable swap futures, their European initiatives, and “ways to replicate swaptions”.
PANEL 2: SEF Readiness
Rosario Chiarenza of Barclays chaired a panel on SEF readiness. His panel:
- Randall Costa, Citadel
- Jeff Moran, MarkitSERV
- Diana Shapiro, Citi
- Nick Solinger, Traiana
- Supurna Vedbrat, Blackrock
Was good to hear the buyside perspective from Citadel and Blackrock. Supurna was very vocal on the block and allocate process that just isnt there yet. CME is working on it (and has a recent press release) but I believe its still very manual. She also voiced frustration that it has taken 3 years for the industry to finally realize that clearing certainty requires 4 limit checks (both clients vs FCMs and both FCMs vs CCPs). I think she is right, I know I’ve had conversations on the topic and people blanketly oversimplify the real problem here that 4 checks are required before that trade is getting cleared. Many are guilty of just assuming a SEF will take care of it, granted SEF’s have been talking about doing certainty checks, but they can only do the client vs FCM side of it.
EGREGIOUS PLUG: We at Clarus provide a great utility for credit and margin checking while giving full risk offsets. Learn more here and tell your FCM’s to check us out!
Randall was optimistic on the opportunity of getting onto an all-to-all SEF and getting the chance to tap into the IDB liquidity, but voiced frustration that the IDBs are closed doors at the moment and the D2C orderbooks are basically empty.
I found the discussion on workflow fascinating. First, there are three methods of SEF connectivity to CCP:
- Direct. SEF sends to CCP
- Middleware. Names were not given but surely this is Markit Trade Manager
- Bunched Order/Allocation flow, which I interpret as direct to CCP, but requiring a standby FCM to handle the allocations.
What I found interesting is for years now I have questioned the business model of middleware in the SEF / Clearing space. Given requirements on speed of execution and clearing, and the fact that a SEF is your defacto confirmation platform, why do I need to click on a middleware platform anymore (assuming you are not doing allocations)? Well, it seems I was right. Randall often referred to the middleware as vestigial middleware – which I thought was appropriate. Diana referred to a case where a trade was given credit/authorised on a SEF, executed, got stuck in middleware for a couple hours, then got to the CCP and cleared. I found it humorous that this was compliant with regulations given that when it eventually reached the CCP, it cleared within 10 seconds!
That delay in middleware serves nobody well. Hence back to Supurna’s comment that the allocation process needs to be fixed, and we might be able to get away from the middleware/indirect SEF flow. Middleware would then only serve a purpose for bilateral contracts.
Nick even sited a case of a trade being executed on a SEF with credit given by FCM 1, trade went to middleware, the client changed to FCM2, and it cleared at FCM2! I can only imagine the confusion (and grief) this may have caused for the FCM’s.
Jeff then argued that we’ll possibly see the day that bilateral trades that require allocations will be put through the SEF just to take advantage of an allocation process, which would completely remove the need for middleware.
LONG IN THE TOOTH
This is longer than I had intended. I’ll save details on my lunch (the line for Noodles was too long so had to have a chicken wrap!) and will try to just give highlights for the last two sessions I attended. Anyone still there?
Session 3: Certainty of Clearing
Chris Perkins of Citi had a panel of:
- Commisioner Wetjen, CFTC
- Kim Taylor, CME
- Chris Edmonds, ICE
- Will DeLeon, PIMCO
- Steve Mahoney, Credit Suisse
- Nathan Ondyak, LCH
Bill at Pimco likes the recent guidance on voided trades that get rejected “ab initio” – meaning as if it never happened. I think this topic has been beaten to death, and in my attempt to make this brief, I would summarize the session as Bill asking the panel every 10 minutes “why cant we just do it like in futures?”. The answer is we are trying to. DCO’s have work to do on the block/allocation model, but the focus is just this, be like futures.
Session 4: OTC vs Futures
Kevin McPartland chaired the final panel that I attended. He had:
- Neal Brady of Eris
- Chris Edmonds of ICE (I felt like Chris was on nearly every panel I walked into)
- Jeffrey Howard of RBS
- Sean Tulley of CME
- Don Wilson, DRW
Whenever Don Wilson speaks, you listen. Don is the perfect example of who everyone in the industry is trying to serve. You can get senior people from Blackrock, PIMCO, Citadel, etc, etc, they are all important. However, they are just employed to be in charge of some part of a machine that turns out requirements for derivatives. Don is DRW, and he eats derivatives for lunch. We should all thank him.
Don said DRW is carefully evaluating providing liquidity for OTC on SEFs. However this would require being a Swap Dealer, which brings unwanted side-effects, ending in being “expensive”.
Neal discussed their standardized and custom products, and Sean of course (who clears for Eris) discussed the success of the “competing” deliverable swap futures. I felt it a bit awkward that Neals’ success is being held up by the progress of CME who quite rightly have more important things to figure out. I wish them both well. In particular, Neal was very innovative and came up with their product before the CME had theirs, so I hope Eris have success.
For the sake of time, I would summarize the main content of the session in bulletpoints:
- Clients are focusing on compliance first. Next will look to cost, which might mean going to futures
- There will always be a need for bespoke OTC, but if the cost/benefit of having some small basis risk to a standardized product can be justified, futures might work
- Ironically, the Credit market recognized this years in advance of the crisis and went standardized (ala MAC)
- Give it some time to pan out. Markets are very good at answering questions like this!
Apologies to those who have emailed me asking where my day 2 summary is. I am not a professional blogger, am a slow writer, and after 2+ days of attending an event, I have a day job I had to get back to!
Thank you all for reading!