Wall Street brokers question FTX futures trading plan
A trade group representing some of Wall Street’s biggest brokers has warned US regulators that a proposal by cryptocurrency exchange FTX to automate risk management in the leveraged futures market lacks sufficient detail to be approved in its current form and could prove disruptive.
The FTX plan has caused a stir in the financial world, raising the prospect that trading approaches being developed in crypto markets will find broader uses in traditional finance if the Commodity Futures Trading Commission, a US regulator of derived products, gives its approval.
Wall Street’s response has been eagerly awaited as FTX seeks permission to use computers to perform functions in the futures markets now performed by brokers, known as futures brokers, the largest of which are subsidiaries. of JPMorgan Chase and Goldman Sachs.
The Futures Industry Association, which represents market participants including FCMs, on Wednesday called on the CFTC to seek additional information before deciding on the FTX plan, describing it as “innovative” and possibly “transformative” but potentially risky.
“This model could exacerbate financial instability at a time of heightened market volatility,” the FIA said, adding that it fears the automated system invites “market manipulation” by bad actors.
The CFTC set a May 11 deadline for comments on the FTX proposal, which received mixed reception. Terry Duffy, managing director of futures exchange operator CME Group, called it a “demonstrably flawed” idea that “presents a significant risk to market stability and market participants”. Given the significance of the issues raised by FTX, other respondents suggested that the CFTC would be better off drafting new regulations.
As a sign of the debate to come, a House committee will hold a hearing on the plan on Thursday, with Duffy and FTX chief executive Sam Bankman-Fried among the scheduled witnesses.
FTX is seeking CFTC approval for a small U.S. futures exchange it bought last year to offer leveraged futures contracts, which allow investors to take large positions while accumulating a fraction of the value of a transaction, called margin.
In today’s markets, FCMs collect margins and ensure clients have enough to support their positions. If they don’t, the brokers ask for more money, usually overnight. They also contribute to collateral funds held in clearinghouses – the third parties standing between buyers and sellers of futures contracts – to “mutualize” losses in the event of default.
FTX would bypass brokers, using a system currently used in crypto. This would require clients to post collateral in FTX accounts and be responsible for having enough to cover margin requirements, which would be calculated every 30 seconds each day.
If the margin falls too low, an automated liquidation will begin, with FTX first selling the positions in 10% increments. In the worst case, the positions would be taken over by “backup liquidity providers” who had agreed in advance to play such a role. FTX would also inject $250 million into a guarantee fund.
Although the FTX exchange only deals in digital assets, approval of its proposal could pave the way for its approach to be used for other futures contracts.
The FIA argued that crucial details of the FTX plan remained unclear, ranging from the reliability of the algorithms it uses to calculate margin requirements to the terms of “backing liquidity providers”. He asked what would happen if a market player made a “big finger” mistake or if FTX itself went bankrupt.
The trade association has also advocated for human intervention in the markets. FCMs not only deal with margin, he said, but also try to ensure clients have sufficient resources to negotiate and monitor money laundering activity.
Automated liquidations could make a bad situation worse, the FIA said. “During market turmoil, the immediate liquidation of a large participant during cascading markets can . . . add to market volatility and may lead to further defaults,” he said, putting the emphasis on the “expert judgement” of financial services professionals in knowing when to act.
Requiring market participants to maintain accounts 24/7 would be impractical outside of the crypto arena, he said, placing an excessive burden on investors using the money deposited in banks.
“To respond to a margin call in fiat currency, banks must be open, even if the market is open 24/7,” the FIA said. “That’s not the world we live in today.”