The challenges faced by market participants in managing volatility in the commodity and energy markets was a key theme during discussions at FIA Forum Milan, with panellists saying that markets held up well despite the extreme circumstances.
"Between February and April, we observed huge spikes in volatility in all commodity markets, and especially in energy, power, gas and the emissions markets, with daily changes in prices that we have never observed before," said Dario Luciano Merlo, head of brokerage platforms at UniCredit.
"After that, prices stabilised at levels ten times higher than before the turmoil. It was unprecedented but despite that, the markets and our clients proved to be resilient."
Merlo continued, "In Italy, no major market participants needed government support or defaulted or made the headlines in any significant way. Of course, there were unusual trends, such as extended liquidity support from banks, but overall, the commodity derivatives markets were resilient and able to sustain our clients' activities."
He added, however, that there was still room for improvement in the functionality of the markets, such as greater use of circuit breakers or suspensions to protect prices from suffering steep variations within short periods.
Giorgio Cali, BNP Paribas's head of derivatives execution and clearing institutional sales EMEA, agreed about the resiliency of the cleared derivatives markets and noted that OTC cleared markets were particularly strong.
"That's not to say the commodity listed side was not strong or even stronger, but we saw, for example, more clients trading swaps to hedge positions. We have seen in the last 10 to 15 years a switch from bilateral trading into cleared listed or OTC cleared, but that switch was even stronger in the last six months," Cali said. "We have not seen major failures. The system is working and is proving to be strong."
Offering a broker's perspective on how volatility has impacted the Italian markets, Carmine Calamello, head of brokerage and execution at Intesa Sanpaolo, said listed derivatives have become a key product for his clients.
"The last couple of years has been characterised mainly by strong participation in the equity cash business, but this year listed derivatives is having the best year ever for us. We saw good retail client flow coming to us. From our institutional investors, there was less trading, much more positioning for hedging purposes and less interest in the single names - the exception being Italy - and more interest in equity derivatives," he said.
"Our corporate clients have been active in the energy space and have been trying to face and resolve the big issue of the initial margin requirements and collateralisation."
For IDEM, Euronext's Italian derivatives market, volumes have grown significantly this year as more institutional investors have turned to the exchange to hedge their risks.
"Volumes on IDEM have gone up around 20% year-to-date and we have seen much more institutional flow," said Massimo Giorgini, head of Italy equity, derivatives, and structured products sales at Euronext. He pointed in particular to the futures on the FTSE MIB index, the main benchmark for the Italian stock market.
"If you look, for example, at our FTSE index futures, the growth has come from DMA, electronic flows, quantitative funds, and liquidity providers, much more than in 2020 and 2021 when retail flows were significant in our markets," Giorgini said.
In Italian equity options, institutional investors are trading more actively, with primary markets, including IDEM, able to regain market share over alternative venues, he said.
"We are seeing lots of buy-side investors, such as pension funds and insurance companies, approaching listed derivatives exchanges because of market conditions where they need tools to hedge tail risk much more than before," he added.
The panellists also discussed the challenges they had faced during periods of excessive volatility in energy derivatives markets, with UniCredit's Merlo noting that margin had increased by up to five times during peak days.
"Higher margin requirements started to have an impact on the leverage ratio of banks," Merlo said. "We had a few months where we had to understand how to treat margins on balance sheets, how to optimise and reduce these impacts.”
BNP Paribas's Cali noted that a big theme for clearing members and clients has been how to predict or anticipate spikes in initial margin and a desire for improvements in the transparency and predictability of margin calls.
"We developed a tool a couple of years ago to let clients project margin call on a specific transaction based on the book of trades they already had with us. We didn't see a lot of use of that tool initially, but in the last six months we have seen an uptick in usage because clients really want to anticipate the initial margin requirement from CCPs," he said.
Simona Composto, executive director, prime services at Goldman Sachs, noted that during periods of high volatility, clients turned to her firm's trading desk to execute on risk or on block to minimise execution risk. In addition, variation margin was much bigger than in previous years, putting intense pressure on clients' treasury desks to try to put up enough cash, she said.
"As volumes have increased, there has also been more focus, not only by market participants but by clients too, to try to streamline the give-up process in the futures markets and make it more efficient," she said.
The give-up process, where a client sends an order to their chosen executing broker, which then gives it to another broker to clear, was a particular trouble spot when futures volumes spiked in 2020 amid coronavirus volatility. Operational bottlenecks led to a large number of trades breaking, resulting in missed margin payments and positions left on the books of the wrong brokers.
The panellists said market efficiency has improved since then but agreed that more work needs to be done.
"We have seen a huge increase in volume from 2020 to 2022 with peak days 22% higher in 2022 than two years ago. At the same time, our STP rate has increased from 82% to 90%. So, what has changed between these two years?" said Composto. "Effectively, what came out of the 2020 increase in volume was an analysis of what we can do better as an industry."
Agreeing with Composto, Intesa Sanpaolo's Calamello said 2022 had been better compared to the outbreak of the pandemic because the industry understood that trade processing, automation, and STP processing were vital to tackling bottlenecks in the system.
Composto talked about the work her firm had undertaken to improve operational efficiencies as well as the need for collaboration among industry participants.
"As a clearing broker, we looked at the process and we have invested a huge amount to increase capacity and STP. We've also looked at the allocation process and looked to improve some of the connectivity with particular exchanges. Our clients themselves have looked at how they allocate the trades to us, but the ecosystem is incredibly convoluted still and there are elements such as average pricing or symbology, which create bottlenecks," Composto said.
To address operational problems that came to the forefront in 2020, FIA has created an independent body called the Derivatives Market Institute for Standards (DMIST) to develop standards and best practices in the post-trade workflow. The initial focus of the industry-governed body is on allocations and give-up processing, average pricing, and reconciliations.
"We realise that as an industry, we need to work together. This is why initiatives such as FIA's DMIST are incredibly important to try to standardise the market and create more capacity," said Composto.
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