Trading volumes are rising, new products are emerging and some financial markets are moving closer to round-the-clock operation. But developments in trading must be accompanied by progress in clearing and post-trade infrastructure, according to FIA President and CEO Walt Lukken.
In a recent Behind the Market Structure interview with Kevin McPartland, head of market structure and technology research at Crisil Coalition Greenwich, Lukken discussed how the derivatives industry has strengthened its operational resilience and where further changes could create capacity for growth.
The conversation covered capital reform, US Treasury clearing, prediction markets, tokenisation and the operational implications of a shift towards round-the-clock trading.
Resilience
Lukken said the sharp rise in trading following the Iran incursion in March highlighted the progress the derivatives industry had made in strengthening its operational capacity.
Trading volumes were 88% higher than during the Covid shutdown, while the time to settlement fell by 75%. Despite the jump in activity, the market handled the volumes in what Lukken described as a close to business-as-usual fashion.
“It was just like a normal trading day, almost a yawn for the marketplace,” he said. “To me, it feels like we’re making good progress on the operational side.”
That performance followed work undertaken since the strains experienced in early 2020, when record volumes contributed to a backlog of trades awaiting allocation to the correct accounts.
In response, FIA worked with industry participants to establish the Derivatives Market Institute for Standards (DMIST), which develops standards aimed at improving the efficiency and resilience of post-trade processing.
Those efficiency gains are increasingly important as derivatives markets grow, said Lukken, noting that the volumes recorded during the Covid disruption no longer rank among the industry’s 100 busiest trading days.
Capacity
Capital treatment will also affect the market’s ability to accommodate further growth.
Lukken said two central aims of the post-financial crisis reforms – encouraging central clearing and increasing capital requirements – had begun to conflict. While policymakers sought to reduce systemic risk by expanding central clearing, the capital treatment of cleared products constrained the balance sheets of firms supporting those markets.
“We did get more things into clearing, but the two policies started to work against each other,” he said.
Recently proposed Basel III reforms and US Federal Reserve reforms on capital requirements for global systemically important banks (G-SIBs) could free up some balance-sheet capacity, while creating stronger incentives to use what Lukken described as the “safe environment of clearing.”
The introduction of mandatory central clearing in the US Treasury market could also create further efficiencies, particularly through arrangements that allow for the cross-margining of Treasury securities and related futures positions.
Guardrails
The rapid growth of prediction markets is presenting regulators with a separate set of questions. Lukken said the simplicity of the contracts had helped them attract younger users, but their expansion raised questions about the products offered and the safeguards surrounding them.
Whether CFTC-regulated markets should list contracts linked to sport, politics or popular culture was ultimately a public policy question for Congress, he said. The CFTC must also consider how event contracts are self-certified and how its rules address manipulation, insider trading and retail access to leveraged products.
Lukken nevertheless sees considerable potential in the sector, particularly in contracts linked to economic events and in the information generated by their prices.
“I’m pretty confident within two years these will start to institutionalise in really positive ways,” he said. “I think even on the economic side, we haven’t even scratched the surface.”
Round-the-clock clearing
As traditional markets explore longer trading hours, influenced in part by the growth of 24/7 crypto markets, tokenisation could help address a significant challenge: moving collateral when banks and conventional payment systems are closed.
Tokenised assets could potentially allow value to move overnight, at weekends and during holidays, helping clearing systems manage open exposures as trading hours expand.
“Once we start to do that, it removes the friction of moving value and quickens the time to clear those trades,” Lukken said. “That’s getting risk out of the system faster.”
Significant operational hurdles remain, however, and he estimated the industry could begin to see practical benefits from tokenisation within three to five years.
Similar considerations apply to 24/7 markets. Clearing arrangements must be addressed alongside any extension of trading hours, he said.
Not every product requires continuous trading. Instead, the transition should be demand-driven and considered product by product, with many commercial hedging products, particularly in agriculture, dependent on liquidity being concentrated within established trading hours.
But where markets do move towards continuous trading, clearing must be part of the transition. “If a market is going to move to 24/7, clearing needs to move to 24/7,” he said.
