March’s clearing failures give new life to an old idea

It was a rough year for clearing brokers. Wild market swings and a toughened capital regime put immense pressure on the industry. Firms struggling to make the risks and returns stack up started hiking fees, offloading clients or exiting the business altogether.

Amid the carnage, one or two futures commission merchants (FCMs) proposed an idea that would cut everyone’s costs and make their lives simpler: a new utility to standardise the post-trade workflows and message formats that connect clients to executing and clearing brokers, and on to clearing houses. If everyone participated, the argument went, the upfront costs would be spread; but enough firms had to participate to reap the benefits and make the whole endeavour worthwhile.

The year was 2015; the utility never took off, and the industry carried on as before – right up to the point when Covid-19 slammed the markets, and everything broke. The former head of clearing at one of the banks pushing the utility watched with dismay as some of the largest brokers wrestled with delays and outages during the chaos that enveloped the futures industry in March 2020.

With calls for a utility growing again in the aftermath, he can’t help a rueful chuckle. “Maybe the world is different now,” he says, “but no-one was close to agreeing back then.”

Six years ago, those making hay in clearing could be forgiven for turning up their noses. The markets generally functioned pretty well at scale, and the biggest FCMs had no incentive to bankroll a utility that would ease the pressure on their struggling competitors.

There was, as they saw it, a good reason why blue-chip asset managers chose to trade with them: they got a bespoke service, and support for often archaic, manual workflows; and they didn’t have to call a utility that supports multiple different brokers when something went wrong.

Technology for them was a differentiator, notes the broker; the futures business was, and is, “dog eat dog”, and others wanted no part of the utility “because it helps level the playing field. And the biggest banks didn’t want the playing field levelled”.

Fast-forward to 2020, and some of the largest brokers were among those buckling under the deluge of orders.

There are structural reasons for this: one of the unseen factors behind the chaos was the use of average price allocation algorithms by the largest fund managers to divvy up gains and losses on trades across the hundreds or even thousands of accounts they manage.

Because they can only do that at the end of a trading session, the result on heavy trading days is an increasingly unsustainable flood of orders.

Buy-side use of listed derivatives has increased exponentially in the intervening time, too, in parallel with the rise of clearing and margining mandates for over-the-counter swaps, and the over-the-counter market’s attendant decline. That makes the need for a futures-specific utility – de rigueur in newly cleared swaps markets – all the more pressing, three of the biggest FCMs in the market tell Risk.net.

One factor that could stop FCMs getting round the table with CCPs now is bad blood between all sides. The industry came together to clean up the trade breaks in the days and weeks that followed March, but behind closed doors, accusations and counterclaims continue to fly from both sides – even after publication of Risk.net’s multi-month investigation into what happened. The ever-present animus between brokers and CCPs over margin model procyclicality shows few signs of abating, either.

What any new utility looks like, and who gets to run it, are also vexed questions.

Given the present depth of ill feeling in many quarters, perhaps the industry should have struck while the iron was cold.