The global pandemic and rocketing transaction volumes and volatility that immediately followed created unprecedented challenges for cleared derivatives markets across many elements of the trading cycle. However, a panel of senior managers at exchanges and execution and clearing providers in Asia Pacific expressed a shared view that the industry performed remarkably well despite the extraordinary pressures it faced.
Speaking on a webinar hosted by FIA on 12 August on what worked well during the pandemic and what needs to improve, the panelists pointed to industry preparedness through business continuity planning as a key factor in the resilience of the markets.
Bradley Fraser, head of prime derivatives services, Asia Pacific at Barclays, said the industry's resiliency was testament to the work it had done in the past "wargaming" scenarios of disruption.
"It is testament to the fact that we haven't wasted opportunities, whether it be a market event in the US or in Asia, or an external crisis outside the market, such as a tsunami or SARS in the past. We've been able to look at these situations, learn where the stress pain points are, and really leverage off that, which helped us in this scenario," he said.
Fraser also pointed to the robustness of technology at a time of unprecedented volatility and high volumes when staff were operating from home.
"When we had the SARS event, the technology just wasn't there to have everybody working from home while keeping the markets running," he said.
Russell Beattie, APAC head of futures and options, OTC clearing services and FX prime brokerage, Bank of America Merrill Lynch, also pointed to the significant investment the industry has made in systems scalability and stability as well as client education programs on electronic trading.
"If we go back to SARS we would have been in a situation where all that volume would have had to go through a high-touch desk", Beattie said. “The client education program over the last 10 to15 years – encouraging clients to send orders by FIX messaging, making sure that we're doing everything STP as soon as we possibly can – the industry really benefitted from that."
From an exchange perspective, Helen Lofthouse, executive general manager for derivatives and OTC markets at ASX, said that during an extraordinary period of volatility, futures markets proved their value as a venue for price discovery and liquidity.
"It was clear that the futures markets were the source of price discovery for multiple instruments, and the fact that we were able to bring participants together from all over the world from all different types of companies to pull that liquidity actually made a huge difference," she said. "It really emphasized for me the crucial importance of the futures market and the role it plays in managing systemic risk."
Lessons learned from the pandemic
However, the panelists were open about the challenges created by high order volumes and trade backlogs during the peak of market volatility and discussed how the system could improve its response to the next crisis.
Lofthouse said that while processes involving STP generally worked well, there were issues involving manual processes that created delays in give ups – a procedure where an executing broker places a trade on behalf of a client and then transfers the resulting position to the client's clearing firm.
"There were pain points that we were hearing about from our customers where they were relying on some manual processes and these were creating delays, particularly in give-ups on peak days. This has a knock-on effect, because if those trades aren't being picked up for give-up, it's the execution broker who is then paying the margin," she said.
Speaking from an FCM perspective, Sharon Shi, managing director, G.H Financials (Hong Kong) talked about her concerns regarding extensions to post-trade allocations.
"Some FCMs complained that the window to process allocations by clients was too tight so they asked for an extension from CCPs,” Shi said. “Our concern is that if CCPs provide extensions for those FCMs to allocate those give-up trades, then it would be delayed to the end of day, which means their system might not be ready and our system might not be ready in time for the next business day."
Shi added, "Another problem is that with the give-up business, if CCPs are calling for intraday margin calls when the give-ups are not being taken, the executing brokers are carrying huge margin risks."
Beattie said that further investment in middleware and automating manual confirmation processes would help the industry in the next crisis.
"FIA, I know, is engaging with various FCMs on this. We need to look at ways in which we can automate that approval process instead of waiting for an email confirmation from a client to say, 'Yes, I did X amount of lots at X amount of price'. There is a lot of work that we're doing, but investment in middleware, client selection and automating confirmation processes would definitely help in the next crisis," he said.
Lofthouse added that ASX is working to add transparency to the give-up process for market participants.
"We have a set of rules around give ups and we're looking at monitoring people's compliance with those rules…Hopefully as we evolve, that will help give clearing participants more transparency on what their performance is like relative to the average, because I think people are operating in the dark,” Lofthouse said. “There might be people who are slower and have some process issues who think that is just the normal practice. Bringing more transparency and metrics to that is something that we're looking at."
Futures margin methodology and whether it needs to evolve was another topic up for discussion on the panel.
A recent FIA industry sentiment survey showed that three quarters of respondents had said margin volatility and unpredictability was one of the biggest challenges they faced during the pandemic.
"There is a general awareness that there have been significant increases in margin, which puts stress not only on the CCP, but more specifically the clients," said Barclays' Fraser. "This is a big topic and a great opportunity for us to come together as an industry, rather than have bilateral discussions, to actually work out, how do we solve this?"
Agnes Koh, senior managing director, chief risk officer at the Singapore Exchange explained how the exchange sets its margins.
"This [pandemic] was not a normal market condition, so you would expect that margins would increase, " she said. "Over the years, we have put in procyclicality and counter-procyclicality floors. I was looking in comparison with some of the other markets that we have products in and over a period of two months margins went up about 53%, but in the same product in another market, it went up 125%. This is because we had a floor and the floor helped hold it."
A recording of the webinar can be accessed here for more on what worked well, what could be improved, and what is needed to ensure the safety and security of markets in the future.
- Operational Resilience