There are many things that have changed about global derivatives trading over the decades, from the way our markets work to the products that are listed. But one thing that will never change is the critical importance of price discovery.
On-exchange interactions between buyers and sellers may not seem particularly glamorous or important. But they form the very foundation of fair and efficient markets. Buyers need to know they are acting on the latest information, and getting a price that's no worse than any other buyer at that moment. Similarly, sellers need to know they are being treated just as fairly.
Price formation that is efficient and transparent builds confidence in the entire system. In fact, businesses who have never traded in our markets rely on these prices every day to make economic decisions like hiring employees or investing in equipment. Trust in these derivatives prices is critical to decision-making that ultimately moves our economic engine forward.
Unfortunately, we have witnessed the chipping away of confidence and trust in market-determined prices recently. That's because sometimes markets reflect prices that are unwelcome or problematic, resulting in calls for policymakers to get involved.
This week, FIA filed an amicus brief with the Texas courts defending the sanctity of "finality" of price settlements in the futures markets. In our comments, we explained why disrupting final prices could have devastating effects beyond Texas and this specific event. If you recall, weather events around Winter Storm Uri in 2021 caused electricity prices to soar as generators went offline just as demand spiked. The resulting sticker shock on home utility bills led to calls by politicians to reset the settlement price of the of the local power market, which in turn determined the settlement price of ICE and Nodal futures contracts.
Something similar happened last year in Europe, when natural gas prices soared as Europe's previous reliance on Russian energy caused extreme volatility during the Ukraine invasion. Headlines warned that many European citizens may have to go without heat last winter if prices remained elevated thanks to this supply shock. With no short-term fix to address this supply problem, policymakers in Brussels enacted a price cap that would artificially keep futures prices in check, despite real-world supply and demand dynamics. In response, markets contemplated moving these energy products outside of the EU.
It's unfortunate, but there seems to be an increasing number of case studies where market-led price discovery has been challenged. Each example is unique, with its own circumstances. But what they share is a movement by regulators or policymakers to second-guess prices discovered on our markets and adjust them in the name of "fairness."
But what about being "fair" to hedgers? After all, futures contracts are just that – a binding contract, that must be respected.
It undermines public faith in derivatives markets when policymakers revise prices up or down after trades are booked in public markets or formalized through settlement processes. Commercial hedgers using derivatives markets for risk-management strategies have to be certain their trades will be honored, or else they won’t get the price certainty they require. Well-functioning and trusted markets have many benefits beyond providing certainty to hedgers, too. They promote free competition, innovation and efficiency as both sides of a trade look for an "edge."
And big picture, these price signals are fundamentally important to the real economy. After all, if we put a cap on the price of fossil fuels like oil or natural gas, then there's less incentive to invest in alternative energy sources. If we're trying to quantify the very real consequences of climate change and CO2 emissions, putting a thumb on the scale doesn't seem a great way to achieve that goal.
There are admittedly many challenges posed by the complex nature of modern financial systems. But one thing that should be easy for even outsiders to understand is the critical importance of price discovery.
FIA understands that when you're dealing with real-world consequences like the cost of heating your home, high prices can be very unpopular among politicians. That's universally true around the world, from Washington to London to Brussels.
But markets that discover these uncomfortable pricing trends are not the problem in these situations. They are simply a thermometer that measures the amount of demand and supply.
In fact, I'd argue that our markets can be part of the solution to these challenges. High prices can be an indicator of larger issues such as structural supply and demand imbalances that must be addressed – and regulators and politicians who notice these signals could be spurred into action to mitigate these larger concerns.
But to look to cap or reset high prices is treating the symptoms, not the disease. Worse, it undermines the integrity of public markets.
FIA will continue to be a public voice in defense of price discovery on behalf of our markets, and on behalf of the broader economy that derivatives markets serve.
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