FIA submitted comments to the US Commodity Futures Exchange Commission in response to the agency’s Request for Comment on the Direct Clearing of Derivatives by Retail Participants. FIA’s letter commends the CFTC for seeking the industry’s feedback on direct clearing for retail derivatives market participants and potential conflicts of interests in vertically integrated market structures. These rank among the most important issues facing the agency with the proliferation of both retail trading and affiliated entities in recent years.
FIA shares the CFTC and Chairman Mike Selig’s interest in exploring new efficiencies and innovative changes that can benefit risk management and strengthen US derivatives markets. FIA’s letter offers a simplified regulatory approach for new retail-focused market structures that respects the statutory framework established by the US Commodity Exchange Act where central clearing is present and invites the agency to consider a modified regime where central clearing is not desired or offered.
The CEA created a regulatory framework for the clearing of derivatives that distributes responsibility for the clearing ecosystem across various registrants: designated contract markets offer a central marketplace for price discovery, derivatives clearing organizations ensure settlement of trades, and futures commission merchants guarantee and provide market access and credit to end users as highly-capitalized members of the DCOs. Each registrant in the chain plays a critical, interdependent role in support of the execution and clearing of derivatives contracts.
Derivatives trading traditionally has involved leverage and loss mutualization. As leverage carries inherent risks to market participants and the clearing system, the CEA and CFTC rules allocate regulatory and risk management obligations among registrants. Customers are screened for credit, risk tolerance and compliance with applicable anti-money laundering and customer identification requirements; settlement cycles and margin calls disperse risk; and minimum capital requirements, residual interest and default rules reduce and mutualize risk within the clearing system. All of these are preconditions for customers to trade on a leveraged basis and, as the enduring history of U.S. cleared derivatives markets has shown, in combination promote safe and sound clearing.
In light of the rise of retail trading, FIA invites the agency to consider a simpler approach that would clarify the rules of the road for all venues and market participants. Where leveraged clearing is present, the CFTC should retain registrant categories and separate, interlocking functions of the FCM clearing members, DCM, and DCO.
By contrast, the CFTC could create a regulatory scheme with streamlined risk disclosures, direct trade placement and settlement requirements commensurate with the comparatively decreased risk to individual traders and the clearing system when a DCO is authorized to clear fully collateralized, pre-funded positions – that is, positions that do not involve leverage or extension of credit – and enrolls retail participants directly without intermediation by FCM clearing members. FIA’s letter sets out a detailed framework for the proposal.
FIA’s letter also explains how existing CFTC regulations do not sufficiently address the potential for conflicts of interest where a DCO has supervisory authority over an affiliated intermediary. Addressing this omission may require a fundamental reconsideration of the controls a DCO in a vertically integrated structure is required to implement. Where a DCO is permitted to have an affiliated FCM clearing member, the CFTC should require any such DCO to insulate its commercial interests from its supervisory and oversight functions. This includes prohibiting the DCO from carrying out audits under CFTC Regulation 1.52 of either its affiliated FCM clearing member or any non-affiliated clearing members.
FIA looks forward to working with the CFTC and industry stakeholders on these important issues to ensure US derivatives markets continue to set the standard for innovation and integrity for decades to come.
