IDX 2023: Extreme volatility over the last year should build confidence in derivatives markets’ resiliency

At FIA’s International Derivatives Expo, panellists praised the derivatives markets’ ability to cope with extreme volatility, while highlighting that latency should be a priority to ensure resiliency moving forward.

Despite extremely volatile markets over the last year, including energy market supply chains being disrupted by the conflicts in Russia, panellists at FIA’s International Derivatives Expo said the industry could take confidence in the fact that markets were still able to function well.  

Panellists noted that the derivatives market should be optimistic about the future, especially given that the combination of high-quality market design and centralised clearing was able to see the market steer through exceptional volatility.

“Certain technologies around margin transparency and particularly the advent of portfolio margining across the board, will be a very positive element and will enable people to be more resilient going forward,” said Chris Rhodes, president of ICE Futures Europe.

Risk management has also been noted by panellists as an important area of focus to ensure derivatives markets continue to be fit for the future, with the last 18 months demonstrating that prudential risk management is a critical part of all businesses.

“Risk is back. We’re reminding people that risk is real and needs to be managed, which I think is good. You’ve also seen a focus back on the points of resiliency,” said Derek Sammann, senior managing director, global head of commodities, options and international markets at CME Group. 

Elsewhere, panellists said CCPs had been able to perform adequately in extreme market conditions in recent years – noting that the industry has seen multiple 100-year events take place in a span of just 10-15 years. Post-financial crisis, central clearing – and it being mandated for certain standardised derivatives – was noted as a successful piece of regulation, demonstrating that the system works.

“However, we also see now that there is an unanswered question in the regulators eyes about what the normalised rate environment does to the non-bank financial system,” said Erik Mueller, chief executive of Eurex Clearing.  

“There is less concern about the large banks, but there is concern about how a risk-free rate that goes from zero to 5% will trickle through all the pockets of the financial system. CCPs will stay and product needs will evolve.” 

Moving forward, latency is an issue which needs to be focused on to ensure trading can maintain efficiency in volatile periods, argued panellists.

“If you engage on pre-trade control dynamics, there is a negative impact on latency,” noted Mike Kuehnel, chief executive of Flow Traders.

Kuehnel argued that from a liquidity provisioning perspective, pre-trade control is not coming in as a burden for market participants, but more importantly it should drive alignment into making sure that risk will improve, ensuring that trading is where it needs to be.  

“The structural impact is that we are incentivising market participants that are able to deploy advanced technology in order to have best-in-class risk management controls internally. That’s an endeavour we would very much embrace because it’s not just the availability of more data and hopefully more interoperable markets, it’s also the ability of each market participant to use risk tools in order to be able to drive risk return decisions in an instantaneous manner.”