Advocating for a stronger US options market
09 January 2018
From regulation to bitcoin, John Davidson of OCC discusses what the world鈥檚 largest equity derivatives clearinghouse is watching in 2018
Image: Shutterstock
One thing is abundantly clear as we begin 2018: the exchange-listed options industry will continue to be affected by various regulations and risks in the year ahead.
OCC hopes that the US Securities and Exchange Commision (SEC), under the leadership of chair Jay Clayton, will be able to streamline its rulemaking review process so that a number of straightforward issues impacting options, systemically important financial market utilities like OCC, and exchanges can move forward at a faster pace in order to better serve market participants.
For one, the process around assessing the options regulatory fee (ORF) remains complex and something that is still determined by individual exchanges as opposed to being standardised across the industry. While exchanges have legitimate regulatory costs that we all benefit from, there is an acute need to rationalise those costs. I believe that in 2018, we must work toward a more transparent, consistent, and simpler means of ORF assessments. OCC, as the ORF collection intermediary among exchanges, can help facilitate progress toward a resolution.
Additionally, options industry market makers are being put in a tough spot today by regulators exploring potential changes to market structure, such as introducing speed bumps. While some view these as protective measures that give some market makers a price advantage over high frequency traders, the measures are also unintentionally driving some market makers out of the transaction lifecycle entirely and ultimately cramping liquidity for market participants executing options orders. I see the exclusive focus on price in speed bumps as a fundamental flaw to any market structure adjustments, especially considering the rise of index and passive investing.
Price may be important to market participants, but so are execution certainty and size visibility. While the SEC chairman has been quite sympathetic to this challenge, this mission remains: whatever changes regulators look to roll out in 2018, it will be important for them to consider the real-world impact those changes could have on the volume of options market makers, who are the lifeblood of this industry.
2018 also is presenting itself as the year of institutionalised trading of cryptocurrency derivatives. OCC has the infrastructure in place and successfully cleared the record new product contracts the industry experienced with bitcoin futures debuting on Cboe on December 10. OCC stands ready to process bitcoin futures for Nasdaq鈥檚 launch as well. However, it will be critical for the industry to remain alert to the volatility that comes with bitcoin and related currencies. OCC has a great deal of confidence in our system for theoretical analysis and numerical simulations margining system, which has a two-day liquidation horizon, to handle products with this kind of volatility, although the volatility levels of bitcoin-like currencies are less relevant for a central counterparty that clears related futures trades due to our not less than daily mark-to-market settlements among clearing members.
Even so, a well-regulated derivatives market should dampen the volatility in the underlying instrument based on other products that have demonstrated similar stabilisation over the years. Only time will tell how bitcoin performs in a regulated setting, so it will be equally important for OCC and regulatory bodies like Financial Industry Regulatory Authority, the SEC, and the Commodity Futures Trading Commission to monitor how the product stands up against concerns around its volatility.
One of the other big issues that the industry should address in 2018 is the very significant operational risk associated with the clearing member transfer agreement (CMTA) and exchange give-ups. The current system puts the carrying clearing member at a tremendous amount of risk that it doesn鈥檛 have any way to mitigate. It is important to tackle these concerns in a very final way. As a result, both the Securities Industry and Financial Markets Association鈥檚 options committee and the OCC roundtable will work to address these concerns in 2018.
As we work toward this, there are three key CMTA issues that will need to be addressed. First there are industry standard CMTA agreements, where currently only one clearing firm has a right-of-return agreement between the carrying clearing and executing clearing firms in transactions. Second, there are customer group identifiers for CMTAs, where clearing firms are burdened by the fact that they have no way of determining the customer source of CMTA trades. Lastly, mitigating the immitigable risks of exchange give-ups as with very few exceptions, virtually all options exchanges allow any member to give-up a trade to any OCC
clearing firm.
I am optimistic about the ability of our industry to meet these challenges in 2018, and my OCC colleagues and I am ready to work with our partner exchanges, clearing firms, and market participants to create positive change that benefits the US
financial marketplace.
OCC hopes that the US Securities and Exchange Commision (SEC), under the leadership of chair Jay Clayton, will be able to streamline its rulemaking review process so that a number of straightforward issues impacting options, systemically important financial market utilities like OCC, and exchanges can move forward at a faster pace in order to better serve market participants.
For one, the process around assessing the options regulatory fee (ORF) remains complex and something that is still determined by individual exchanges as opposed to being standardised across the industry. While exchanges have legitimate regulatory costs that we all benefit from, there is an acute need to rationalise those costs. I believe that in 2018, we must work toward a more transparent, consistent, and simpler means of ORF assessments. OCC, as the ORF collection intermediary among exchanges, can help facilitate progress toward a resolution.
Additionally, options industry market makers are being put in a tough spot today by regulators exploring potential changes to market structure, such as introducing speed bumps. While some view these as protective measures that give some market makers a price advantage over high frequency traders, the measures are also unintentionally driving some market makers out of the transaction lifecycle entirely and ultimately cramping liquidity for market participants executing options orders. I see the exclusive focus on price in speed bumps as a fundamental flaw to any market structure adjustments, especially considering the rise of index and passive investing.
Price may be important to market participants, but so are execution certainty and size visibility. While the SEC chairman has been quite sympathetic to this challenge, this mission remains: whatever changes regulators look to roll out in 2018, it will be important for them to consider the real-world impact those changes could have on the volume of options market makers, who are the lifeblood of this industry.
2018 also is presenting itself as the year of institutionalised trading of cryptocurrency derivatives. OCC has the infrastructure in place and successfully cleared the record new product contracts the industry experienced with bitcoin futures debuting on Cboe on December 10. OCC stands ready to process bitcoin futures for Nasdaq鈥檚 launch as well. However, it will be critical for the industry to remain alert to the volatility that comes with bitcoin and related currencies. OCC has a great deal of confidence in our system for theoretical analysis and numerical simulations margining system, which has a two-day liquidation horizon, to handle products with this kind of volatility, although the volatility levels of bitcoin-like currencies are less relevant for a central counterparty that clears related futures trades due to our not less than daily mark-to-market settlements among clearing members.
Even so, a well-regulated derivatives market should dampen the volatility in the underlying instrument based on other products that have demonstrated similar stabilisation over the years. Only time will tell how bitcoin performs in a regulated setting, so it will be equally important for OCC and regulatory bodies like Financial Industry Regulatory Authority, the SEC, and the Commodity Futures Trading Commission to monitor how the product stands up against concerns around its volatility.
One of the other big issues that the industry should address in 2018 is the very significant operational risk associated with the clearing member transfer agreement (CMTA) and exchange give-ups. The current system puts the carrying clearing member at a tremendous amount of risk that it doesn鈥檛 have any way to mitigate. It is important to tackle these concerns in a very final way. As a result, both the Securities Industry and Financial Markets Association鈥檚 options committee and the OCC roundtable will work to address these concerns in 2018.
As we work toward this, there are three key CMTA issues that will need to be addressed. First there are industry standard CMTA agreements, where currently only one clearing firm has a right-of-return agreement between the carrying clearing and executing clearing firms in transactions. Second, there are customer group identifiers for CMTAs, where clearing firms are burdened by the fact that they have no way of determining the customer source of CMTA trades. Lastly, mitigating the immitigable risks of exchange give-ups as with very few exceptions, virtually all options exchanges allow any member to give-up a trade to any OCC
clearing firm.
I am optimistic about the ability of our industry to meet these challenges in 2018, and my OCC colleagues and I am ready to work with our partner exchanges, clearing firms, and market participants to create positive change that benefits the US
financial marketplace.
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