9 Comments
Oct 2, 2022Liked by Jeffrey Carter

Exactly. We seem set on "progress" but forget the impacts it has on the average trader/hedger. We always forget about the hedger here who does not possess the experience nor speed of the average computer. I would say be careful what you ask for especially around the FTX proposal.

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Oct 2, 2022Liked by Jeffrey Carter

There is a lot to chew on in your comment but let me hit a few topics. Full disclosure here, I worked for FCM's and the CME in my tenure in Chicago.

1. I agree that the FTX model is a bit looney to think 30 second margin calls improve the futures biz. In the eyes of FTX this tends to reduce exposure on a crypto that moves has large price swings and making those calls will be a pain to FTX in the present model. Take for example a grain farmer in Iowa who has a credit line with his bank to pay margin calls, buy seeds, gas, tractors. Imagine having this farmers account dinged every 30 seconds for margins. He would have to maintain more cash in the account which adds to his costs in raising the product. Lets not even touch on the "big brother" grabbing money from the account without him/her knowing about it.

2. FCM's do add that buffer for the exchanges when errors/deficits/etc happen. After working at the CME I can tell you they have no human talent on staff right now that could handle this biz so you are correct to say that staffing up would be great....possibly competing with FCM's for that talent. FCM's also have that group of GIB's/trading advisors/etc that add value to the chain. I envision the CME being a discount broker type of operation if this goes through.

3. I agree CME doing this is preparation in case the CFTC approves FTX plan. Agree again that you never underestimate CME when it wants to compete....known Terry too long and have seen it happen several times anyone got into the CME space.

Honestly, I think change is typically good for the futures biz. The trading floors were due to find competition from the screen and the screen won. I rode that curve with my clients and benefited from it with better and more timely fills. But this change from FTX is not a benefit to the client. It only helps the exchange reduce risk....which they charge for that now.

Tony

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author

You bring up great points that people ought to pay attention to. I am struggling to see how it benefits the client but more importantly an orderly market. If the market had a voice and could speak, what would it say? How would it want to be treated? In the switch to electronic trading, I think we forgot to speak up for "the market" and got so focused on speed and efficiency we screwed up some markets.

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Efficiency tends to win that’s a big part of the FTX model. FCMs add friction, cost, for what can mostly be automated away. Is it a perfect solution? Likely not but the discussion was long overdue.

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Oct 2, 2022Liked by Jeffrey Carter

Totally agree with your first point. I cant think of any customer who would want 30 second margining over daily margining. As to the CME or the FTX becoming the sole FCM - how does the clearinghouse work? If Goldman, Morgan Stanley, JP Morgan, Credit Suisse etc are not FCMs - they arent going to be in the clearinghouse. Without a clearinghouse of big stable banks - counterparty risk becomes a major issue. In addition these FCMs sell the CME product - is the CME going to cover European Pension Funds and Asian hedge funds for their futures business in their time zones? They would have to deal with every small entity that the FCMs currently cover - it doesnt really make any sense.

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author

This is a very good point that I didn't bring up but brought up in the link. The FCM guarantees your trade and they are on the hook for you. In the FTX model, if someone can't perform; what happens?

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Oct 2, 2022·edited Oct 2, 2022Liked by Jeffrey Carter

Its not just that they guarantee their trades - when the Barings collapse in the Nikkei 225 futures was going to bankrupt Barings - the rest of the clearinghouse was on the hook for Barings trades. The clearinghouse self polices itself due to the fact that a member of the clearinghouse can take down the other members. If the CME is providing the guarantee on its own - there will be enormous counterparty risk compared to today's clearinghouse guarantee. Does the CME even have assets of any reasonable size to give that type of guarantee?

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The clearinghouse has a massive insurance policy. It used to be "good to the last drop". We changed that in 1999-2000. It holds billions of dollars of assets. The key is to get margin correctly. One issue is a rogue actor, like Corzine. Or, if an exchange totally caves to one customer as the LME did this year in nickel. If they self cleared with self FCM their insurance costs would go higher.

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There is a marginal cost to efficiency. Is it worth the marginal revenue and risk?

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