Crypto Analytics

Wall Street Brokers Question FTX Futures Trading Plan

A trading group representing some of Wall Street’s biggest brokerages has warned US regulators that a proposal by cryptocurrency exchange FTX to automate risk management in the leveraged futures market is not detailed enough to be approved in its current form, and itself could prove disruptive.

The FTX plan has caused a stir in the financial world, raising the prospect that trading approaches being developed in the crypto markets will find wider application in traditional finance if the Commodity Futures Trading Commission, a US derivatives regulator, announces its consent granted.

Wall Street’s response was eagerly awaited as FTX seeks permission to use computers to perform functions in the futures markets, now entrusted to brokers called futures commission dealers, the largest of which are JPMorgan Chase and Goldman Sachs are.

The Futures Industry Association, which represents market participants including FCMs, on Wednesday asked the CFTC to gather additional information before deciding on the FTX plan, calling it “innovative” and potentially “transformative” but potentially risky.

“This model could exacerbate financial instability at times of heightened market volatility,” the FIA ​​said, adding it was concerned the automated system could invite “market manipulation” by bad actors.

The CFTC set a May 11 deadline for comments on the FTX proposal, which has met with mixed reactions. Terry Duffy, chief executive officer of futures exchange operator CME Group, called it a “blatantly flawed” idea that “poses a significant risk to market stability and market participants.” Given the importance of the issues raised by FTX, other respondents suggested that the CFTC would be better off writing new regulations.

In a sign of the upcoming debate, a House committee will hold a hearing on the plan on Thursday, with Duffy and FTX chief Sam Bankman-Fried among the scheduled witnesses.

Technically, FTX is seeking CFTC approval for a small US futures exchange, which it bought last year to offer leveraged futures contracts that allow investors to take large positions while getting a fraction of the value of a trade, known as Marge.

In today’s markets, FCMs collect margin and ensure clients have enough of it to support positions. If they don’t, brokers will ask for more money, usually overnight. They also contribute to guarantee funds held at clearinghouses — the third parties who stand between buyers and sellers of futures — to “mutually offset” losses in the event of a major default.

FTX would bypass the brokers and use a system currently used in crypto. It would require clients to post collateral on FTX accounts and be responsible for having enough on hand to cover margin requirements, which would be calculated every 30 seconds every day of the year.

If the margin gets too low, an automatic liquidation would begin, with FTX initially selling off positions in 10% increments. Worst-case scenario, positions would be taken by “backstop liquidity providers” who had previously agreed to take on such a role. FTX would also put $250 million into a guarantee fund.

Although the FTX exchange only trades digital assets, approval of its proposal could pave the way for using its approach for other futures contracts.

The FIA ​​argued that key details of the FTX plan remained unclear – from the reliability of the algorithms it uses to calculate margin requirements to the requirements for “backstop liquidity providers”. It was asked what would happen in the event of a “fat finger” error by a market participant or if FTX itself went bankrupt.

The trade association also advocated human intervention in the markets. Not only are FCMs concerned with margins, they also try to ensure clients have sufficient resources to trade and they watch out for money laundering activities.

Automated liquidations could make a bad situation worse, the FIA ​​said. “During market turbulence, the immediate liquidation of a large participant during cascading markets can . . . increase market volatility and can lead to further defaults,” it said, emphasizing the “expert judgment” of financial service providers to know when to act.

Requiring market participants to manage accounts 24/7 would be impractical outside of the crypto space, it said, and would unduly burden investors using funds deposited with banks.

“In order to honor a margin call in fiat currency, banks must be open, notwithstanding that the market is open 24 hours a day,” the FIA ​​said. “This is not the world we live in today.”

Source: Crypto News Austria

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