FIA EXPO: Walt Lukken defends derivatives trading amid volatility, zero-day-expiring options

Walt Lukken, President and CEO of the Futures Industry Association (FIA) spoke to journalists at a press briefing at the recent FIA EXPO 2023.

Lukken touched on various themes, from cutting-edge technology to regulatory challenges, providing a comprehensive overview of the present landscape and a window into what lies ahead.

He also provided thoughts on the absence of crypto advertising at this year’s event, his views on regulatory enforcement in crypto markets, and concerns surrounding exponential growth in options trading.

FIA’s Lukken praises newfound attention to backend technology

Lukken expressed enthusiasm about the industry’s commitment to modernize its systems. “For years we would spend lots of money on front-end trading technology, but the back end of the systems, how the system, the plumbing was ignored for many, many years, but now people get it,” he said. “We have the technological tools to bring to bear that will help make the systems just more resilient, safer, easier to plug and play for competition.”

FIA is spearheading the DMIST initiative, aimed at establishing industry-wide standards. Lukken believes that top-level executives are increasingly focused on “making sure that the market structure of our markets is working properly.”

In light of the ION incident earlier this year, Lukken announced that FIA has published a Cyber Risk ‘After Action Report’. “We really set out to try to improve our ability to reconnect and hopefully prevent, but with the realization and assumption that there will be a cyber attack that’s successful,” he said. The report sets out to connect industry participants better within the broader financial ecosystem.

In response to market volatility seen in Europe last year, FIA also released a paper on volatility controls. “Markets are thermometers, but we want to make sure nobody’s holding a match under the thermometer,” Lukken noted, stressing the importance of having controls in place to ensure market integrity and orderly trading.

When asked about Artificial Intelligence (AI), Lukken said the sentiment ranged from optimism to caution. “There’s nervousness about what does AI mean for people, for jobs,” he said. However, he also highlighted that AI could revolutionize trading and risk management and that both the private and public sectors could collaborate to maximize its benefits.

Finally, addressing the question of regulators falling behind in technological advancements, Lukken said, “They are, but I think the private sector can help the regulators catch up, and we try to do that as best we can.”

Crypto ads missing at this year’s FIA EXPO

In previous years, crypto firms prominently advertised their services at FIA’s events. This year, however, journalists noted that such advertising was conspicuously missing.

Lukken suggested this absence is not a result of FIA discouraging crypto companies but might signify a strategic pivot within the crypto industry itself.

“These are firms that are deciding at a strategic level that maybe they don’t want to be part of the frothiness that I described before,” Lukken said. He emphasized that these companies aim to build legitimate crypto exchanges and products rather than “buying their way into our industry.”

Lukken also discussed the relationship between the cash and futures markets, saying it’s crucial to have an underlying market that is liquid and not susceptible to manipulation. “Let’s make sure that we do everything we possibly can to prevent those types of products from getting listed, but if something slips through the net, let’s make sure that we go after that with strong enforcement authority,” he elaborated.

Distinction between gaming and investing is clearly defined in the law

One of the last points addressed was the explosion in options trading, particularly zero-day expiring options. Lukken mentioned that while this has attracted more people to options markets, customer protections should not be compromised.

“We want to make sure again, that the right investors are informed on the options and what the risks are for those things. And especially leveraged products,” Lukken noted.

Innovation was a recurrent theme, especially with regards to the industry’s approach to volatility control mechanisms (VCMs). Lukken pointed out that these are best practices developed in consultation with global exchanges to maintain market order and disruptiveness.

At the end of the briefing, Lukken dismissed the idea that a tipping point might soon be reached where trading turns into gambling. “I have not heard that,” he stated, adding that the distinction between gaming and investing is clearly defined in the law.

The event served as a comprehensive update on various issues affecting the futures and derivatives industry, reflecting the changing dynamics and concerns as it navigates through regulatory landscapes and market innovations.

Volatility Control Mechanisms (VCMs) for “genuine price discovery”

As to FIA’s report on Volatility Control Mechanisms (VCMs), the paper offers a comprehensive look into the role of VCMs and daily price limits in safeguarding market integrity and facilitating what FIA refers to as “genuine price discovery.”

When queried about what “genuine price discovery” means, Lukken clarified, “Various trigger events highlighted in our paper may cause the market to generate prices that are not reflective of actual market conditions. VCMs try to mitigate the impact of these trigger events.” The paper further elaborates that these mechanisms are crucial for market participants in managing risk during periods of volatility.

According to the report, VCMs aim to “ensure the market can process a volatility event without compromising market integrity, reliability, and utility.” These mechanisms are aligned with the guidelines defined by the Committee on Payments and Market Infrastructures and the International Organization of Securities Commissions (CPMI-IOSCO) in 2018. They serve to minimize disruptions caused by various trigger events, such as obvious erroneous orders, large aggressive orders, and feedback loops that may result in large price swings, commonly known as Flash Crashes.

Daily price limits to address market volatility concerns

Addressing the subject of daily price limits, the FIA argues that “daily price limits should be designed to address the specific needs of a particular contract, taking into consideration the dynamics of the contract, the interconnectedness with other related contracts, and hedging needs of participants, among many factors.”

This nuanced approach aims to accommodate the intricacies of different market segments, especially in commodities, where there is a heightened demand for such limits.

According to the FIA, designing price limits that cater to the unique characteristics of each contract will not only facilitate genuine price discovery but also add an extra layer of protection against excessive market volatility.

The FIA’s paper comes at a time when market volatility is a growing concern, owing in part to geopolitical tensions and economic uncertainties. As regulators and market participants alike strive for greater transparency and stability, the advanced VCMs and tailored daily price limits proposed by the FIA could serve as vital tools in achieving these objectives.