ne of the derivatives industry’s most significant gatherings takes place each spring when the Futures Industry Association (FIA) convenes its annual convention. The 2016 event, held in mid March in Boca Raton, Florida, arrived amid debates over the timing of what would be only the second interest hike by the Federal Reserve since the markets began convulsing in 2008. That is a stark indication of the depth of dislocation in the economy that the financial crisis caused.
Market stability and regulation were topics of heated discussion at Boca. Another prominent topic was the future structure of the industry as new technologies and innovations create opportunities for investing and hedging but also pose regulatory challenges.
FTI Consulting spoke with Walt Lukken, FIA’s current President and CEO, to hear his views on the topics. Walt, a former Acting Chair of the U.S. Commodity Futures Trading Commission, also shared his thoughts on how the annual convention offers industry participants opportunities to network with peers, make news about their own firm and have a voice in shaping the industry.
Daniel Del’Re: What are the biggest misconceptions that non-financial audiences have about the derivatives markets or financial markets in general?
Walt Lukken: I think there is a perception among the general public that the financial markets, and specifically the listed derivatives markets, are casinos that people use purely to profit for their own benefit. The reality is that those markets are used by companies across the economy to hedge price risk and improve efficiency in pricing their products, whether they are agricultural products, banks loans to local communities, energy companies pricing rates or airlines keeping the price of flights reasonable. All those folks are involved in our market, hedging price risk in ways that have benefits for consumers and the economy at large. In this way, the financial markets make sure the economy is driving forward on a daily basis.
DDR: One prevalent view of financial markets is that they are too complicated and need to be simplified.
WL: That is something we think about. There is always concern with complexity. One of the lessons from the financial crisis was that if you could somehow bring bilateral agreements that take place off exchanges into a transparent exchange environment – one that is regulated and makes use of clearinghouses to guarantee trades – then the tangled and opaque web of complexity could be improved and we could help reduce risk in the markets. That is the direction we’ve been moving in over the last eight years. Today we see greater transparency. We see trades taking place in safer, more highly regulated environments with more guarantees. So the perception that markets are overcomplicated is rooted in the structure of markets prior to 2008. Today, a lot of those transactions take place in a much simpler, more transparent environment.
DDR: What could derivatives firms do to educate policymakers about the way that the industry is changing as a result of new technology and innovations?
WL: The innovative spirit of our industry is something we are proud of. They key is for regulators and industry to work together to create a dialogue about new developments so innovation isn’t hampered, but also so regulators have the tools they need to oversee markets.
There is a trend toward automation transforming the industry, including the way that it is regulated. Regulators are using technology to improve the way that they collect and analyze data. We see these efforts not only in the pre-trade environment, but also in the post-trade environment. There has been a lot of discussion about Blockchain technology that allows an enhanced audit trail of what has happened and when money has moved, which can speed up the settlement process, lower risk in the system and hopefully lower costs as well. These are all things that we think can benefit the system and hopefully the end-users in our markets.
DDR: Is there an imperative for firms in the industry to do more to educate policymakers about what they are doing and the role of technology?
WL: Absolutely. FIA has undertaken various efforts to do a better job of talking about the benefits that automation brings, from lower costs to added liquidity and improved the safety and soundness of clearinghouses. There are a lot of positive aspects to the automation and we’re trying to educate folks about it. One of the ways we’re doing that is through conferences, such as Boca, which different regulators attend and where there are panels talking about various aspects of innovation. There are also mechanisms within FIA such as webinars and the Institute for Financial Markets, which is the educational arm of FIA through which we conduct training and educational programs on this exact topic.
DDR: What does the upcoming presidential election mean for the derivatives industry or for the financial markets in general? What’s at stake for the industry?
WL: The markets generally do not like uncertainty, no matter where it comes from, whether politics or the economy. The presidential election brings a significant amount of uncertainty. On top of that, markets are also following the referendum in the United Kingdom over whether to exit the European Union, the volatility in China, and the price of oil and uncertainty that it’s causing in the Middle East and globally.
This uncertainty motivates people to come to the markets and try to hedge risks, which is what our markets are intended to do. The good news is that financial markets provide an outlet for people to hedge risks to their business, including political risks.
DDR: Are there aspects of Dodd Frank that are at risk in the presidential election?
WL: I don’t think so. Dodd Frank is pretty much woven into the fabric of markets at this point. Most of it has already been implemented.
DDR: What should the public know about risks in the financial system, especially those that led to the Global Financial Crisis?
WL: To begin with, we are safer than we were before the crisis. Banks are holding more capital. We have more safety and soundness throughout the system. Several rules have been put forward to strengthen clearinghouses and make sure they work correctly.
The problem is that for each additional rule that is intended to reduce risk, there may be undesirable inadvertent consequences. For example, as costs accumulate from the implementation of certain regulations, we see a consolidation among the clearing members and exchanges. Also, some clearing members are exiting the business. We may reach a point where policymakers conclude that some of our efforts to strengthen the system have led to “too big to fail” concerns because of consolidation as firms try to manage rising costs.
We have to be reflective and understand what the actual impact of each marginal rule. We have to have a frank discussion and ask whether it will solve a problem or lead to unintended consequences that add risk to the system.
DDR: Let’s talk about Boca. What makes Boca a good forum to make news?
WL: I think there are a number of reasons. We bring together high-level executives from the entire industry in one location – customers, clearing members, exchanges, vendors and regulators. This allows people to find information and have conversations that are otherwise not possible throughout the year. They can announce deals because the entire community is there. We’ve seen that happen in past years. They can talk about policy agreements as well. With regulators and industry executives in one location, they can make progress on certain policy initiatives that are up for discussion. Networking is also a big benefit to attending the conference. You never know when a casual introduction will lead to the next innovation or the next deal in our industry.
DDR: Tell us about the 2016 convention. What were some of the highlights?
WL: Because it's such an uncertain time for our industry as costs continue to rise, which in turn can affect infrastrucutre, our theme this year was the future of our industry. We had great keynotes, including our traditional CFTC chairman’s address. Condoleeza Rice gave a keynote that touched on the presidential elections and global political risks that may impact the economy and our industry. Boca always offers a chance to talk about the role of innovation and technology, which sparked interesting discussions and views on the future of the industry.
DDR: Could you make the case that the industry has learned to govern itself better since the financial crisis, in particular, that self-regulation works and is necessary?
WL: You have to look at it holistically. Individuals have to be self-disciplined and so do the firms themselves, which is a role for internal compliance. You also have the self-regulatory organizations overseeing firms and individuals, as well as the regulatory authorities.
There has always been a tradition in our industry of self-regulation. Since the financial crisis, there has been a greater impetus within the industry to get in front of issues and prevent them from bubbling up and becoming problems. I think self-regulation still works and will be an important part of the fabric of regulation going forward.
DDR: Is there anything else you wanted to mention about the work you do at FIA?
WL: I would call attention the work that FIA does on standards and best practices. For example, we’ve put forward a letter on clearinghouse risk that makes suggestions on how to improve the system. We’ve also issued whitepapers and proposed other best practices on electronic trading and they’ve not only proved useful for our membership, but also for regulators considering these issues.
DDR: Walt, thank you very much.
WL: It’s my pleasure.