Building the foundations for successful derivatives markets

FIA President and CEO Walt Lukken's opening remarks at FIA Expo 2023

2 October 2023

Opening remarks of Walt Lukken, President and CEO of FIA, at its Expo conference in Chicago on October 2, 2023.

Welcome to Expo, and welcome to the Sheraton Grand Chicago Riverwalk. Rolls right off the tongue!

There is so much about the city of Chicago that I love. It’s a city of hard-scrabbled individuals who work hard and play hard.

It’s a city of risk takers and innovators who aren’t afraid to break glass. And there are examples of this everywhere.

Take Comedy... Just think about the gutsiness and genius of Chicago’s improv movement that launched the careers of John Belushi, Gilda Radner, Chris Farley, and many others.

Economics... Consider Milton Friedman, George Stigler and other Nobel economists of the Chicago School, who challenged how we think about markets, individual freedom and rational choice.

And of course, Architecture... Think about how this city revolutionized design, giving birth to the modern skyline. Architects like William Jenney and Daniel Burnam experimented with bold techniques like floating foundations and steel frames, which gave birth to the first skyscrapers.

Some call Chicago the "Second City" because of its rivalry with New York. But most Chicagoans are too proud, confident, or busy innovating to take offense.

The "Second City" label also derives from the rebirth of this city after the Great Chicago Fire of 1871 that destroyed nearly 17,000 structures across four square miles.

This city didn't give up after that blaze. And it didn't just rebuild what it had before. It forged something new … something better.

Chicago created things like the Home Life Insurance Building. Built in 1885, it is credited as the first skyscraper at 10 stories and 138 feet tall. 

Think about that. With Chicago in ruins, its leaders built something no one had ever imagined.

Folks here literally redefined what a cityscape should look like… That's the spirit of this city.

So, it's no surprise that the founders of the derivatives industry called Chicago its home. Our industry has the same pioneering spirit.

We challenge assumptions. We aren’t afraid to fail.

And we often take the path less traveled, in pursuit of a better future.

The current exponential pace of change presents many opportunities—as well as challenges—for our industry. Between artificial intelligence, quantum computing, and big data, the possibilities for our markets are breathtaking.

But responsible innovation is only possible if the foundations of our markets are structurally sound.

If we want to build a better future for our markets, we must invest in their infrastructure to ensure they are accessible, safe, and resilient for all participants.

Not unlike the skyscraper, you can’t build up unless the foundation is solid below. Our industry must modernize our market infrastructure to enable competition to flourish.

And if we are successful, literally the sky is the limit.

One of the most tangible ways FIA has been working to modernize this foundation is the Derivatives Markets Institute for Standards, or DMIST for short. We formed DMIST last year to raise the operational standards of our markets and improve their resilience.

I'm pleased to report that DMIST has quickly made significant progress, publishing its first standard in June on the timeliness of give-up trades and allocations.  

This standard marks an important milestone in our work to improve operational efficiency.  It also is an important indicator of the power of working together as an industry.

We are also looking at modernizing risk management. There has been increased focus on how derivatives markets manage risk amid recent volatility, with heightened scrutiny by policymakers.

Rather than sit back, this industry recognized the need to lean forward on this topic. So last week, FIA published a report that lays out best practices around volatility controls for exchanges.

The report also recognizes the importance of allowing exchanges flexibility in the adoption and administration of these tools.

This was the result of collaborative work from a broad array of FIA members, from prop traders to the exchanges themselves, and we thank everyone for their contributions.

FIA has also been tackling the cybersecurity of our markets to ensure we are prepared when such attacks occur. And believe me, they will occur.

The cyber disruption earlier this year was a wakeup call. But once again, it showed how our industry could come together when it matters. 

Last week, an FIA taskforce published an “After Action” report that makes several recommendations on strengthening our resilience after a cyber-attack. These include forming a standing Industry Resilience Committee, improving information sharing, and affirming best practices for recovery and reconnection.

The report also recommends integrating our industry better into existing cyber exercises, with a specific focus on exchange traded derivatives.

This is a perfect illustration of how our industry learns from our experiences and builds a better future, from the ground up.

All of these collaborative efforts—from standard setting to risk controls to cyber resilience—are an investment in the foundation of our markets. And they ensure our markets are sturdy enough to take on the growth and innovation ahead.

There is one more structural issue that is also worth discussing—that is, the shrinking number of clearing members across the board, and a recent proposal that could quicken this trend.

This summer, U.S. prudential regulators announced a massive plan to raise capital on banks to come into compliance with international capital standards.

Contained in the proposal are changes that go beyond these standards and would raise the amount of capital for the clearing of over-the-counter derivatives.

This is a dangerous move that disincentivizes hedging, runs counter to financial crisis reforms, and ultimately will increase costs for consumers and businesses.

When I was head of the CFTC during the 2008 financial crisis, I had a front-row seat to the volatility and uncertainty of that time. Mortgage markets seized up, and stock markets plunged.

Many pointed to complex OTC derivatives as a leading cause of the near-collapse of the financial system.

At that time, I wrote in the editorial pages of the Wall Street Journal that we needed to move more of these products onto regulated clearinghouses. After all, the futures industry worked extraordinarily well during the crisis.

The G20 nations agreed and recommended clearing OTC derivatives to make the markets safer, holding up the futures industry as a model of reform.

This audience knows why clearing is crucial to the resilience of financial markets. Regulated central clearing provides important controls that compartmentalize functions and socialize risk.

Clearinghouses, intermediaries, and end-users serve as important checks on one another. And every trade is supported by its own private capital in the form of margin and default fund contributions, lowering the risk of a taxpayer bailout.

If the proposal stands, it may cause some banks to question the viability of customer clearing as a business model. Banks will have to make tough choices about whether to raise costs or limit clearing capacity.

Exacerbating the issue is the limited number of bank FCMs that provide clearing services for over-the-counter swaps today.

When post-crisis reforms came into force in 2014, there were 22 firms that provided OTC clearing. Today there are only 12 clearing banks with 7 of these firms making up 94% of the market. This trend is concerning.

More than a decade ago, policymakers correctly recognized the need to incentivize clearing. Today, nearly 90% of interest rate swaps are cleared at US registered clearinghouses. These reforms should be celebrated for making the markets safer.

In the coming weeks, FIA plans to remind bank regulators why these structural investments were made in the first place. FIA stands ready to defend the importance of clearing, and the public benefits it provides.

As you can see, it has been a busy year! But FIA, like most of you, has been energized by this work.

That's because there are many reasons to be optimistic—whether it’s record volumes, new products, or the thriving rates and energy markets.

I also feel a renewed sense of innovation in the air. Our industry is loaded with entrepreneurs experimenting with AI, blockchain and other technologies to modernize our markets and rethink the best way to clear, trade and manage risk.

If you don’t believe me, you need to go down to the trade show floor and visit our amazing exhibitors, including our Innovators Pavilion.

These companies represent our future. And we're excited to see how they will disrupt and reshape our markets for years to come.

What an exciting time to be in this industry! That's why I’m passionate about our efforts to modernize the foundations of our markets. These efforts involve many hands and I’m thankful for the support and work of this community in advancing this mission.

So, thank you … for being members of FIA, and allowing us to earn your trust.

But we adjourn, let me leave you with one final thought.

When you exit this hall and look out those big windows at the amazing Chicago skyline, remember the resilience of this city. Remember those leaders who dared to think differently.

These visionaries overcame adversity to build a better future from the foundation up. And this industry is cut from the same cloth.

I am so proud to be a part of a community that embraces progress and challenges the status quo. That’s what I love about this city ... and our industry, wherever we call home!

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