Key CFTC divisions urge caution as firms respond to clients that want extended trading hours.
Derivatives clearing organizations, designated contract markets, swap execution facilities (SEFs), and futures commission merchants (FCMs) have been put on notice by the Commodity Futures Trading Commission (CFTC) that its Divisions of Clearing and Risk, Market Oversight, and Market Participants have some concerns about 24/7 trading, clearing, and settlement.
Grygo is the chief content officer for FTF & FTF News.
Those concerns form the basis for a staff advisory about firms that want to extend their trading and/or clearing operations to accommodate clients seeking 24-hour, 7-day services and support. Derivative instruments that are based on cryptocurrencies or other digital assets are forcing the issue. But not all instruments can easily be thrown into the 24/7 arena.
“For example, derivatives referencing crypto assets may be well-suited for 24/7 trading due to their digital infrastructure and global reach, while other derivatives markets, such as in agricultural products, may be less suited for 24/7 trading due to their unique customer bases, regional nature, and the specialized trading and hedging practices in those markets,” according to the advisory.
So, given the surge in interest in 24/7 trading, “the divisions seek to encourage responsible innovation in these markets,” and they are reminding participants of “their regulatory obligations pursuant to the Commodity Exchange Act and Commission regulations thereunder,” according to the CFTC.
In particular, CFTC staff “will engage in a detailed review of any plans and associated analysis, to determine whether the extension of market hours complies with the CEA and Commission regulations thereunder. As such, Commission staff recommend that any DCMs, SEFs, or DCOs considering 24/7 trading or associated clearing operations for specific products or markets, and FCMs seeking to intermediate such operations, engage with Commission staff beforehand,” the advisory notes.
For instance, CEA and CFTC regulations specify that DCMs and SEFs “must, among other things, implement risk controls, conduct real-time market monitoring, establish system safeguards, and maintain sufficient compliance staff and resources,” according to the advisory.
For the settlement process, Division of Market Oversight officials “believe DCMs and SEFs should avoid offering contracts that settle during off-peak periods, such as overnight and weekends in the underlying market, which may result in manipulation, disruptions of the settlement process, as well as trading, market, and pricing disruptions or distortions,” according to the advisory.
As for clearing, margining, and settlement capabilities “extended trading hours may or may not be paired with a similar extension of hours for clearing services.”
The advisory notes that extended trading hours could mean any of the following conditions for clearing:
- Collateral calls continue to be made only during traditional market hours.
- Participants can opt into posting collateral during weekend hours, or
- Participants are required to post collateral during weekend hours.
For now, 24/7 trading in U.S. derivatives markets “falls in the first of these categories. This approach may reflect operational frictions related to the movement of certain collateral types over the weekend, as well as concerns that imposing collateral calls over the weekend may place undue liquidity demands on market participants,” the advisory notes.
“Where collateral continues to be collected only during traditional market hours, a DCO must still demonstrate sufficient financial resources and liquidity to meet obligations continuously, including over multi-day bank closures, as required by the DCO’s Core Principle B obligations (Financial Resources),” according to the advisory.
“Given this, DCOs should evaluate the impacts caused by a divergence between trading and clearing frequencies on areas including risk tolerances, stress scenarios, and participant behavior, and explain to the Commission any mitigants implemented to ensure that they are still meeting this core principle (e.g., adjusting the size of the guarantee fund, or to margin calibrations, in response to novel risks posed by weekend trading),” according to the advisory.
Overall, the advisory points to key areas that models with weekend collateral exchange could include:
- Operational structures that allow for timely and reliable collateral movement;
- The ability, when needed, to readily convert between collateral types;
- Exposure monitoring during trading periods with participant and liquidity profiles distinct from those of weekday trading; and
- Distinct default management procedures that address weekend risks.
The full text of the advisory can be found here: https://shorturl.at/ADjli
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