Liquidity and margin concerns top areas of market evolution

IDX panel discusses the future of market structure, driven by client demand

20 June 2023


Industry leaders at FIA's IDX conference acknowledged the continued resilience of global derivative markets amid recent disruptions, but noted several new areas of improvement and opportunity as the industry looks to the future with a focus on market liquidity. 

While markets held up well over recent periods of volatility, "there are still question marks across the globe when it comes to market structure evolution, regulatory alignment and harmonization," said Mike Kuehnel, CEO of Flow Traders.  

He noted that a key characteristic of ensuring continued resilience in derivatives markets is improved liquidity provisioning. "Settlement cycles that are not yet fully harmonized globally, and liquidity pools that are not yet fully interconnected," Kuehnel said. 

Erik Mueller, CEO of Eurex Clearing AG, also pointed out that while big banks continue to show strength in a changing interest rate environment, there is increased scrutiny of smaller institutions or interconnected firms that may be affected. 

"There's an unanswered question, in the regulator's eyes, about what a normalizing rate environment does to the larger financial system," Mueller said. "We're at the beginning of a new cycle with new challenges and new opportunities.” 

Operations and market structure 

The panel also discussed operational issues that are potential areas for innovation and improvement, including real-time risk management and the notion of 24/7 markets.  

Flow Traders’ Kuehnel noted that there is a trade-off to consider when implementing new pre-trade risk controls. "If you further engage on pre-trade controls, it has a negative impact on latency." That means it's important to consider the balance to avoid placing a burden on market participants that harms liquidity. 

Chris Rhodes, president of ICE Futures Europe, agreed that liquidity comes first – and market participants should respect where trading currently happens in an efficient and orderly manner. That may mean taking a more circumspect approach to the notion of instantaneous, 24/7 trading environments. 

"Liquidity is scarce," said Rhodes. "Spreading it across more of the day or even the weekend, there is a trade-off there. While I can see the reason for the debate, I think we have to be mindful that today's system does a reasonable job of maximizing liquidity. There can be some improvements, but liquidity doesn't move freely." 

Collateral and tokenization 

Another area the panelists engaged with was potential improvements to collateral treatment, including tokenization. 

Derek Sammann, global head of commodities, options and international markets at CME Group, noted that customers continue to demand "a flexible set of collateral tools" to adapt to the changing market environment. 

"Cash is now a lot more expensive than it used to be, and customers need to know what their options are," he said.  

It's also critical for exchanges to be "crystal clear" about their procedures to better inform customer choice, including their margin cycles and providing both pre- and post-trade transparency. 

Mueller said that there continues to be discussion around the promise of blockchain or tokens to reduce friction in the margin process, but so far those conversations have been difficult to translate into the real world – in part because of technology, but also because of regulatory uncertainty surrounding much of this technology. 

"To me, the question is whether there are some solutions that we can apply in today's world without waiting for governments to come up with new frameworks," Mueller said.  

He also stressed the importance of "decoupling the technology from what we're trying to do with it" to focus on incremental improvements that serve a specific purpose. 

"When we talk about how to drive further innovation into tokenization, there's sometimes this belief we need to find the perfect solution rather than a stage-by-stage approach," Mueller said. 

At the end of the day, said Derek Sammann of CME, the real-world use-cases of customers is fundamentally what will shape the markets of the future. 

"Any initiative is only driven by one thing, and that's client demand," Sammann said. "We tried to go through launching a product or service just because we thought it was a fabulous idea, they started to smell like solutions looking for a problem. There's enough real problems out there." 

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