Between the 19th and 23rd of April, delegates from clearinghouses and exchanges, as well as academics, regulators, buyside and other stakeholders attended the WFE Clearing & Derivatives Conference 2021. The conference builds on a long tradition. Now in its 37th year, it has become the principal global industry meeting on clearing and derivatives. Over the years, the conference has been hosted in markets ranging from Tel-Aviv to Mexico City and from Chicago to Kuala Lumpur; a reflection of the WFE’s global membership.
For the first time since its creation in 1983, this year the conference was held virtually. Despite the obvious challenges we faced, and the fact that market infrastructures are often considered an esoteric topic (with good reason, I believe) more than 500 participants registered for the event—an extraordinary and historic number.
Even so, I want to highlight is a more fundamental achievement. This year, we expanded the scope of the conference, bringing academic research into the mix.
Clearly, we believe in the importance of the dialogue between academia, policymakers, and industry. Academic research aspires to provide rigorous, general, and meaningful answers, untainted by the particular or the subjective. Moreover, it achieves validity by submitting itself to peer challenge. This is a source of its strength. Even so, it often needs to move away from day-to-day detail and, by doing so, academia sometimes risks looking at the issues from too much of a distance. In contrast, industry lies at the core of issues, and yet has limited scope to engage in lengthy (and perhaps too risky) research projects.
Therefore, we can only benefit by bringing together these different but complementary perspectives. With this objective in mind, in October last year we published a call for papers. The Programme Committee, comprising academics, regulators, and industry participants, selected nine research papers to be presented, backed by the usual academic standards of scientific rigour, quality, and relevance of the research.
Running alongside these research presentations, the conference’s five-day agenda included keynote speeches and panels that debated the most important issues affecting the clearing and derivatives sectors. I am responsible for WFE Research and would like to highlight how the selected research papers originated and informed many insightful discussions and presentations.
First, to set the scene, the paper by Albert J. Menkveld [Vrije Universiteit Amsterdam] and Guillaume Vuillemey [HEC Paris], The economics of central clearing, provided a survey and stock-take of the research literature on CCPs over recent decades and proffered an overview of salient topics. These include multilateral netting; protection against counterparty risk; the effect of CCPs on asset prices and fire sales; margins setting; the default waterfall; and CCP governance
An emerging critical perspective
From the various panel discussions, it became clear that, while we are on the path of ensuring the financial stability goals set out in the G-20 agenda eleven years ago, we still need to reconcile the different and often conflicting interests derived from the clearing mandate. While participants recognised what has been achieved, they did not shy away from offering a critical perspective. This was particularly pertinent in raising questions around topics such as the role of Skin in the Game and procyclicality. For instance, while Skin in the Game intended to signal the CCP’s strong incentive to perform consistently prudent risk management, it is insistently misread as a loss-absorbing component, why? Equally, is the procyclicality of margin models really the issue or should participants just be better prepared?
The same can be said about CCP recovery and resolution. How do we, for instance, ensure that markets achieve as much certainty as possible and that incentives are correctly aligned in a scenario in which resolution becomes plausible? There is also the added complexity of having to anticipate potential conflicts of rights and misaligned incentives that may manifest themselves in an extremely uncertain environment.
None of these issues and questions have straightforward answers, but they are not without solutions either. They are man-made problems. Even so, approximating an answer that is consistent with financial stability goals and is robust in anticipating potential outcomes, requires—among other things—grounding it on sound economic arguments, as well as some intellectual courage (and data!). Research can help with this.
Covering questions of liquidity risk transmission across the system, for example, three of the research papers presented at the conference offered illuminating, system-wide perspectives that can contribute to adequately framing the questions around procyclicality. The paper on Systemic stress testing under central and non-central clearing by Barbara Casu and Petros Katsoulis from the Cass Business School and Elena Kalotychou from the Cyprus University of Technology, develops a stress-testing network model and compare defaults due to counterparty and liquidity risks and systemic losses in a regime with and without non-central clearing. They also provide a quantitative assessment of the potential sources of stress in the cleared OTC derivatives markets.
Elsewhere, research by Audrius Jukonis and Linda Fache Rousová of the European Central Bank and Elisa Letizia, from the Single Resolution Board titled The impact of derivatives collateralisation on liquidity risk: evidences from the investment fund sector, uses transaction-by-transaction derivatives data to assess whether the current levels of funds’ holdings of cash, and other highly liquid assets, would be adequate to meet funds’ liquidity needs to cover variation margin calls on derivatives under a range of stress scenarios. On the other hand, Mark Paddrick from the Office of Financial Research, at the U.S. Department of Treasury and Stathis Tompaidis from the McCombs School of Business, at the University of Texas in Austin, in their paper titled Intermediation networks and market liquidity: evidence from CDS markets use supervisory data for the over-the-counter credit default swap market to empirically evaluate how changes in intermediation networks are related to the liquidity of dealers and to test how the market's network relates to the liquidity provision of dealers, both individually and collectively.
Looking more specifically at the procyclicality of margin models, the London School of Economics’ David Murphy and Nicholas Vause of the Bank of England proposed in A CBA of APC a cost measure that allows to perform a cost benefit analysis (CBA) of the different anti-procyclicality (APC) measures.
Panel discussions on Skin-in-the-Game were complemented by the paper by Wenqian Huang and Előd Takáts from the Bank of International Settlements titled Model risk at central counterparties: Is Skin in the Game a game changer? In this instance, the authors investigate empirically how the balance sheet characteristics of central counterparties affect their modelling of credit risk.
Even so, the conference was not only about stock taking of what has been achieved or remains to be achieved from the G-20 Pittsburgh agenda, it also provided a glimpse of some of the challenges ahead. This includes questions such as: what is the role of financial market infrastructure in managing climate-related financial risks? Where do we see modelling of risk evolving in the next years, including the use of new technologies? And how do ensure robust and transparent markets as the derivatives ecosystem changes and expands?
With regards to derivatives, research also brought new insights to bear on the segment. In his research paper, “Competition and manipulation in derivative contract markets”, Anthony Lee Zhang of the University of Chicago Booth School of Business, defines two measures of manipulation-induced welfare losses which can be estimated using market data, as opposed to relying solely on behavioural interpretations of market manipulation. Using proprietary data on cleared interest rate swaps transactions and the dealers' daily margin requirements, a study by Aref Bolandnazar from Columbia Business School, The market structure of dealer-to-client interest rate swaps, develops an equilibrium model of IRS markets with imperfect competition among capital constrained dealers.
Finally, the paper by Kevin Aretz and Ian Garrett from the Manchester Business School, and Adnan Gazi from the University of Liverpool titled Taking money off the table: suboptimal early exercises, risky arbitrage, and American put returns, uses early exercise data of options to analyse arbitrage strategies based on a short put position and a long position in a replicating portfolio.
One of the main takeaways from the event is that a conference format that stimulates the conversation between academia and industry is not only possible but desirable. Researchers benefit from anchoring their assumptions in a correct understanding of how the markets work, and industry benefits from enriching the discussion with the insights and perspectives that research offers. Each side challenges the other and, as I said at the beginning, being open to questioning is a way of stimulating progress and ensuring robust outcomes.
The conference has shown how WFE is not only committed to an open conversation but that it is also uniquely placed to bridge the gap between academic research and industry, as its own research work inhabits just this space. WFE Research will continue seeking to enable this interaction.
I would like to thank the contribution of all our distinguished speakers, discussants, and panellists, and the members of the Programme Committee, who made of this 37th edition a unique and extraordinarily stimulating event, and I am looking forward to seeing you all in person at next year’s edition.