Wednesday, May 25, 2022

A Few Comments on Today's CFTC Staff Roundtable on Disintermediation

I spent much of today watching the CFTC Staff Roundtable on Disintermediation.  The focus of this event was the “disintermediation” or direct clearing that FTX – “an international cryptocurrency exchange valued at $32bn” – proposes to offer to U.S. retail customers (though the option for customers to use an intermediary should still exist).  The House Committee on Agriculture also recently held a hearing on this topic.  Sam Bankman-Fried, the 30-year-old FTX CEO, cofounder and billionaire, is the son of two Stanford University law professors

In a nutshell, FTX proposes to offer U.S. retail customers direct clearing, meaning they would no longer need intermediation by a futures commission merchant (FCM) as under the existing market structure, for cryptocurrencies (at least as the initial asset class).  FTX would calculate margin requirements every 30 seconds and computer algorithms would automatically start liquidating a customer’s positions in specified increments were a customer’s account to be under-margined.  Customers could post a wide variety of collateral, including cryptocurrencies, to meet margin requirements.  FTX plans to also contract with backup liquidity providers who would put up their own collateral as a backup and, potentially, be allocated a portion of a defaulter’s portfolio at a discount to the market price.  Hence, FTX’s proposal would largely automate clearinghouse risk management.  Roundtable participants commented at length upon whether largely removing human discretion from this process was a net positive or negative.    

When I first read about FTX’s clearing proposal (here) for U.S. retail investors, I thought it interesting, but I also worried about several things, including potential market stability issues from the rapid sale of a defaulter’s portfolio and conflicts of interest, particularly with the potential allocation of a defaulter’s portfolio.  Others mentioned similar concerns during today’s Roundtable.  On the other hand, I’ve noted in the past (here) the small number of FCMs and the tremendous concentration of margin being held by these handful of clearing members.  It’s a problem.   Direct clearing could be a potential solution to this issue.  However, direct clearing arrangements can also be problematic as illustrated in the case of an individual power trader directly clearing trades at a Nasdaq clearinghouse in 2018.   

I’ve now started wondering if the general investment risk clearinghouses’ face when they invest customers’ collateral could be exacerbated by FTX’s approach.  I don't recall mention of this concern.  However, what I know for sure is that I’ve much more to learn about this topic and look forward to keeping BLPB readers posted about this issue!

Colleen Baker, Financial Markets | Permalink


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