As we move closer to 2018, one thing is abundantly clear: the exchange-listed options industry will continue to be impacted by various regulations and risks in the year ahead. I recently participated on a panel at SIFMA's annual Listed Options Symposium and had an opportunity to discuss some of the key issues that will be critical for the industry and regulators to address over the next twelve months.
Navigating the options regulatory agenda - the ORF and market makers
OCC hopes that the SEC, under the leadership of Chair Jay Clayton, will be able to streamline its rulemaking review process so that a number of straightforward issues impacting options, SIFMUs like OCC, and exchanges can move forward at a faster pace in order to better serve market participants.
For one, the process around assessing the Options Regulatory Fee (ORF) remains complex and something that is still determined by individual exchanges as opposed to being standardized across the industry. While exchanges have legitimate regulatory costs that we all benefit from, there is an acute need to rationalize those costs. I believe that in 2018, we must work toward a more transparent, consistent, and simpler means of ORF assessments. OCC, as the ORF collection intermediary among exchanges, can help facilitate progress toward a resolution.
Additionally, options industry market makers are being put in a tough spot today by regulators exploring potential changes to market structure, such as introducing speed bumps. While some view these as protective measures that give some market makers a price advantage over high frequency traders, the measures are also unintentionally driving some market makers out of the transaction life cycle entirely and ultimately cramping liquidity for market participants executing options orders. I see the exclusive focus on price in speed bumps as a fundamental flaw to any market structure adjustments, especially considering the rise of index and passive investing. Price may be important to market participants, but so are execution certainty and size visibility. While the SEC chairman has been quite sympathetic to this challenge, this mission remains: whatever changes regulators look to roll out in 2018, it will be important for them to consider the real-world impact those changes could have on the volume of options market makers, who are the lifeblood of this industry.
Bitcoin's debut on exchange platforms
2018 is presenting itself as the year of institutionalized trading of cryptocurrency derivatives. The industry has the infrastructure in place and successfully cleared the record new product contracts the industry experienced with bitcoin futures debuting on Cboe December 10. OCC stands ready to process bitcoin futures for Nasdaq's launch as well. However, it will be critical for the industry to remain alert to the volatility that comes with bitcoin and related currencies. OCC has a great deal of confidence in our STANS margining system, which has a two-day liquidation horizon, to handle products with this kind of volatility - although the volatility levels of bitcoin-like currencies are less relevant for a central counterparty that clears related futures trades due to our not less than daily mark-to-market settlements among clearing members.
Even so, a well-regulated derivative market should dampen the volatility in the underlying instrument based on other products that have demonstrated similar stabilization over the years. Only time will tell how bitcoin performs in a regulated setting, so it will be equally important for the OCC and regulatory bodies like FINRA, the SEC, and the CFTC to monitor how the product stands up against concerns around its volatility.
Increasing urgency to solve risks associated with CMTA and exchange give-ups
One of the other big issues that the industry should address next year is the very significant operational risk associated with the Clearing Member Transfer Agreement (CMTA) and exchange give-ups. The current system puts the carrying clearing member at a tremendous amount of risk that it doesn't have any way to mitigate.
It is important to tackle these concerns in a very final way. As a result, both the SIFMA Options Committee and the OCC Roundtable will work to address these concerns in 2018. As we work toward this, there are three key CMTA issues that will need to be addressed:
- Industry standard CMTA agreement: Currently, only one clearing firm has a right-of-return agreement between the carrying clearing and executing clearing firms in transactions. Throughout the next several months, OCC will work with the industry to develop an industry standard CMTA agreement between clearing members of OCC that will provide specific, agreed-upon terms for why a trade can be returned and a set time frame in which that can happen. The end result will be to provide executing firms with assurance of when they are off the hook for a returned trade and provide carrying firms with the confidence to mitigate transfer risks.
- Customer group identifiers for CMTAs: Today, clearing firms are burdened by the fact that they have no way of determining the customer source of CMTA trades. In the year ahead, I see it as critical that we work to develop some sort of a high-level customer group identifier - separate from a beneficial owner account identifier - on every single non-market maker trade (e.g. X was a Fidelity trade, Y was a Schwab retail trade, etc.). This will save carrying clearing firms the costs involved with origination guess work, providing them with the means to determine where any trade belongs on their books and records.
- Mitigating the immitigable risks of exchange give-ups: With very few exceptions, virtually all options exchanges allow any member to give-up a trade to any OCC clearing firm. The challenge with this is when an improperly executed trade is given up: the rules are unclear as to that clearing firm's ability to return the trade to the member that originally executed it. This all boils down to a recipe for immitigable risk for clearing firms. In 2018, we must also explore a solution to this issue, which could be as simple as giving clearing members veto rights over give-ups.
I am optimistic about the ability of our industry to meet these challenges in 2018, and my OCC colleagues and I are ready to work with our partner exchanges, clearing firms, and market participants to create positive change that benefits the U.S. financial marketplace.
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