Derivatives markets functioned normally amid record volume and unprecedented volatility in March and April, exchange executives said during a virtual discussion that took place June 23 as part of IDX-V. Panelists said they were generally very pleased with the effectiveness of price discovery and risk management functions of derivatives markets even during the most severe periods of volatility in early 2020.
Thomas Book, CEO of Eurex, called the COVID-19 pandemic a "black swan event" that created spikes in both volume and volatility, and that it was "a real life stress-test to look into what are the lessons to be learned." However, Book and his fellow panelists agreed that derivatives markets rose to the challenge without any major disruptions.
Stephane Boujnah, CEO and chairman of the managing board for Euronext, noted that derivatives exchanges played an important role as transparent, regulated venues that can provide "the most reliable and most liquid quotes" to participants in a time of crisis.
"I don't know if we can call it a flight to quality, but clearly there was a flight to robustness and there was a flight to wherever liquidity could be transparently concentrated under these extreme conditions," Boujnah said.
The panelists agreed that the resilience of derivatives markets benefitted from 10 years of regulatory reform in the wake of the 2008 financial crisis as well as extensive investments in technology and new products by the exchanges. But Matt Chamberlain, CEO of the London Metal Exchange, noted that the industry's COVID-19 response still required a great deal of teamwork and cooperation between exchanges and their members. Chamberlain noted that the LME was forced to shut down the Ring, its iconic open outcry venue, and go completely electronic on March 23 on relatively short notice. "That week beforehand was pretty intense and required a huge amount of goodwill from our trading members who had to do a lot of work to help us get that liquidity on screen," Chamberlain said.
"I think the crisis shows that you've got to plan well, but it also shows the very strong linkages that exist between exchanges and their members," he said. "When everybody understands the challenge that we have to overcome, we're pretty good as an industry in responding."
Despite the lack of major disruptions in cleared derivatives markets, panelists admitted that the unprecedented volume and volatility earlier this year did expose areas of potential improvement. A few concerns raised on the panel discussion included the levels of margin increase during the height of market volatility, coordination on market-wide circuit breakers, complications around the physical delivery of commodity contracts in a quarantine environment, and challenges with settlement issues including give-ups and trade breaks.
Stuart Williams, president of ICE Futures Europe, specifically stressed the importance of properly educating futures market participants on "the interplay between physical world and the paper world," particularly in the wake of negative pricing for WTI futures contracts in April. That goes beyond analyzing the unique circumstances of why oil futures behaved as they did, and into a broader effort to understand how markets with "local and physical constraints" might behave.
There was also a shared concern among several panelists that while regulators were understandably acting with urgency amid extraordinary market conditions, public sector officials were perhaps too aggressive in banning short selling bans and discussing shortened trading hours.
Julie Holzrichter, chief operating officer at CME Group, cautioned that market-wide short-selling restrictions or moves to reducing trading hours could backfire by creating more uncertainty for participants.
"It really doesn't make sense to introduce such drastic change in times when you really have to manage risk in the best way you can," Holzrichter said. "Making drastic changes during these incredibly volatile times can be very dangerous."
Optimism for the future
Looking forward, Euronext's Boujnah noted that the "big wave" of Environmental, Social and Governance (ESG) products has not just continued during the pandemic but gathered tremendous momentum. That's in large part because fiscal stimulus measures across Europe are tied to these standards of social responsibility and benchmarked for projects related to climate change and the clean energy transition, he said.
"ESG was around, it was not invented by the crisis. But it was accelerated massively," Boujnah said. And as a result, Euronext and other exchanges will be racing to roll out ESG-related products to capitalize on this global trend.
Beyond products, Matt Chamberlain of LME pointed to the "unprecedented opportunity" of digitization for derivatives markets.
"Certainly in the commodities world, we have found progress quite slow in delivering digitalization solutions to physical players because understandably there are a lot of people who have entrenched positions within those workflows that don't necessarily want to give those up, but also because there is a degree of mutual distrust of centralized systems," Chamberlain said. But thanks to the effective digital response to the COVID-19 pandemic, there is now an increased willingness to engage in this topic.
And perhaps most obviously, CME's Julie Holzrichter noted that the future of the cleared derivatives industry will surely continue to include "both physical and virtual outreach" as exchanges find new ways to interact with clients .
"As a global entity, we've been really happy with our ability to work from home across all of our regions," Holzrichter said. "I think the fact that we've been able to work differently gives us a tremendous opportunity to look at how we want to do things better going forward, within our own company and also with our clients."