On Wednesday, the Commodity Futures Trading Commission hosted an industry roundtable to discuss FTX’s proposal for a new derivatives risk management framework. Someone inadvertently dropped a bombshell on the March 2020 market turmoil that sparked a speculative spasm at FTAV Towers.
Most of the day’s talk naturally focused on FTX’s Sam Bankman-Fried, unusually dressed in a suit for the occasion. Gary Silverman and Philip Stafford of the FT wrote a good article on FTX’s proposal. But @Mechanicalmarkets on Twitter highlighted a sloppy comment from ICE’s Chris Edmonds, director of development for the exchange group:
Naturally, the conversation had wandered off course, and Edmonds reacted to some previous commenters’ insistence on “missing payment” – that is, when someone misses a margin payment, they are instantly in defect and its warranty is lost. This is how the system works in theory, after all. No tears etc.
Here’s the crucial part, with emphasis from FT Alphaville below. The Gerry referred to is Gerry Corcoran, President and Managing Director of RJ O’Brien, a mid-sized futures brokerage firm. Chris is Chris Perkins, the chairman of crypto firm Coinfund (and who runs Citi’s clearing unit amid the pandemic turmoil).
Dave is Dave Olsen, the president of Jump Trading, who was at the roundtable representing the FIA Principal Traders Group.
. . . About Chris and Dave around the idea of ’defaulters pay’. I understand. I love it, it’s true. And it works really well for guys who are in department stores, because they never fail. They want to tell you that they never fail. And we’ll just call it for now. At the start of the pandemic — I won’t name the person, but they’re in the room – there’s been a technical problem. Point: he doesn’t have to worry about it in the proposed model, okay, it’s not there. But it would have been cataclysmic at that time. We knew the problem, right down to Gerry’s point about knowing the customer. We knew where it was. And we chose to give the necessary time so as not to disrupt the market and create greater pressure on it.
So for us, ultimately, it’s our job to do no harm. It’s our job to hold everyone back. It’s the question of when you call the default. There’s a lot of examples in history that many of us around this table have gone through and now say, you know, “I think they’re at fault.” Gerry can say “no, they are not in default”, at this point. And this consensus when this defect takes place, we react rather well.
But I had the keys to the castle at the time, and it would have been a very bad day. And this person is sitting in this room, and they know exactly who I’m talking about.
FT Alphaville has heard rumors that the clearing system has cracked more than authorities let on, but this is the first time anyone in the know has indicated it was close to breaking point.
And make no mistake, it was. According to the BIS, daily collective demands from clearing houses for variation margin, insurance to protect against market price swings, reached $140 billion from just $25 billion a few months earlier. That’s a lot of money to come up with when the markets are in wild convulsions.
Assuming that Edmonds isn’t talking about some of the random pencil pushers at the back of the room, but is presumably aiming his comments at the people around the round table, he’s implying that a sizable US financial institution may have defaulted on its payments. in March 2020 if ICE had been picky about the rules.
Here is the full list of roundtable representatives. (NB, David Murphy of the London School of Economics is missing from the image below.)
Commercial Industry Veteran Jamie Selway highlighted on Twitter that it was likely related to credit default swaps, given the mess in corporate debt markets in March 2020, ICE’s clout in the region, and Edmonds’ job overseeing it.
This is the most likely answer, although we note that ICE also manages the Brent futures contract, and Saudi Arabia’s decision to instigate an oil price war has caused crude prices to plummet and shares on March 8. This week alone, clearers demanded $55 billion in variation margin from banks, well above the $31.5 billion collected just after Brexit.
And Edmonds pointed out that it was a technical issue, which admittedly covers a lot, but it indicates that the anonymous party probably had the money but was struggling to pay on time. ICE clearinghouse rules give members one hour to pay after receiving a special request for variation margin, which may be issued during volatile times. One day, a bank had to find almost 10 billion dollars in 60 minutes. And yes, it required a call to the CEO for authorization.
ICE’s rival, the CME Group, trade bodies like ISDA and assorted academics can be ruled out. Edmonds’ comments about “big stores” imply that it wasn’t one of the smaller outfits, like CoinFund. Edmonds using the pronoun “he” is another clue. Big asset managers like BlackRock and Fidelity are unlikely and are not members of ICE Clear.
So our admittedly half-brazen Sherlock Holmes deductions suggest he was probably a props trader/market maker or one of the big banks – Citadel, Citi, DRW, Jump Trading, Morgan Stanley and Virtu – as the main contenders to live up to the bill. If Edmonds was deliberately trying to obfuscate things with the “he” pronoun, we can also add JPMorgan and Goldman Sachs.
A Citadel spokesperson said after publication that neither Citadel nor Citadel Securities had defaulted in March 2020.
Now, that’s obviously ancient history, and perhaps we’re getting too excited about some throwaway comments. Perhaps Edmonds was referring to some of the wallflower people in the room, rather than any of the headline acts. Nevertheless, for us, it highlights two interesting and still relevant points.
First, that human judgment can still be valuable – even essential – in rapidly changing markets (despite heroic efforts by the LME to single-handedly tarnish the reputation for discretion). Edmonds stressed that he knew the culprit and that there was a larger context not to add to market chaos at the time. Obviously, all of the companies at the roundtable are still there, so it clearly worked.
Second, in their gleeful bashing of central banks, many people seem to have forgotten how close we were to a financial cataclysm two years ago, on top of a pandemic and an economic depression.
There is certainly a debate to be had about when the Federal Reserve et al should have pivoted their stance more forcefully to fight inflationary pressures, and what they should and shouldn’t do now. But it is good to remember how risky things got in March 2020 and the role this aggressive (human) intervention played in preventing financial catastrophe.
(History updated at 5 p.m. GMT to add Citadel commentary.)