The US Federal Reserve, alongside the Federal Deposit Insurance Corporation 

“The events of the past year have been marked by significant volatility and the exposure of vulnerabilities in the crypto-asset sector,” said the agencies in a statement. “These events highlight a number of key risks associated with crypto-assets and crypto-asset sector participants that banking organisations should be aware of.” 

The regulators highlighted the risk of fraud, the susceptibility of stablecoins to run risk, contagion risk due to interconnections between crypto players, a lack of maturity and robustness with regards to risk management measures, and the absence of governance mechanisms to establish oversight of the sector.  

Legal uncertainties with regards to custody practices were also flagged, along with the risk of “inaccurate or misleading representations and disclosures by crypto-asset companies” and other practices that may be unfair, deceptive, or abusive, which the regulators warned could contribute to “significant harm to retail and institutional investors, customers, and counterparties”.  

The “significant volatility” within the crypto markets was also raised as a concern.  

The statement acts as a stark warning to those banks involved in digital assets – which include some of the biggest on Wall Street. The regulators stressed that they will be supervising any banking organisation that “may be exposed to risks” stemming from crypto as well as “carefully reviewing” any future proposals from banking organisations to engage in activities that involve crypto-assets.  

It is a clear (and long-awaited) sign that the authorities plan to more rigorously enforce risk controls around the crypto space – and it sends a strong message that, no matter what institutions may have hoped for in the past, the prospect that regulated entities might be able to hold or trade native assets on their own books is still a long way away.  

“Based on the agencies’ current understanding and experience to date, the agencies believe that issuing or holding as principal crypto-assets that are issued, stored, or transferred on an open, public, and/or decentralised network, or similar system is highly likely to be inconsistent with safe and sound banking practices,” said the statement.  

The stance was announced on the same day that the US Attorney’s Office for the Southern District of New York (SDNY) launched a new FTX Task Force with the goal of reclaiming lost assets, according to CNBC reports. The task force will seek to trace and recover investor funds lost in the crash, estimated to be up to $8 billion (including $3.5 billion believed to be held by regulators in The Bahamas), as well as pursuing prosecutions related to FTX.  

“The Southern District of New York is working around the clock to respond to the implosion of FTX,” said Damian Williams, SDNY US Attorney. “It is an all-hands-on-deck moment. We are launching the SDNY FTX Task Force to ensure that this urgent work continues, powered by all of SDNY’s resources and expertise until justice is done.” 

Also on 3 January, FTX founder and former CEO Sam Bankman-Fried appeared in court pleading not guilty to federal charges of fraud. He was extradited to the US from the Bahamas to face charges just before Christmas. Former colleagues Caroline Ellison and Gary Wang earlier pleaded guilty to their own federal charges.

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On 27 June the European securities markets regulator recognised for the first time the two CCPs which are also supervised by the US’ Securities and Exchanges Commission (SEC) and Commodity Futures Trading Commission (CFTC).

The development follows news on the 4 April that the European Commission had adopted amendments to the Commission Implementing Decision (EU) on the equivalence to EMIR’s requirements of the US regulatory framework for CCPs that are authorised and supervised by the SEC.

In contrast, UK CCPs LCH, LME and ICE Clear Europe have only been granted three-year temporary equivalence so as to reduce EU institutions’ reliance on them post-Brexit.

Speaking to The TRADE earlier this week, Deutsche Bank’s head of electronic fixed income, platform, and listed derivatives sales, Mario Muth, said derivatives clearing volumes had already begun migrating over to Europe despite the time limited equivalence.

“The efficiency of central clearing works best if all activity is in one clearinghouse, but the market is big enough to have multiple CCPs be liquid enough to be credible offerings. Each clearinghouse has a niche. CME is strong in dollar products of course,” he said.

“Eurex will be stronger in European products. LCH has traditionally been the leader in the overall share. There is no significant impact to liquidity if the current activity its split a bit more and of course we expect clearing volumes across the industry to grow.”

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David Ye joins the OCC bringing with him over 20 years of industry experience, most recently serving as chief risk officer for State Street Global Markets and global head of market risk for seven years.

Prior to joining State Street, Ye spent five years at investment bank Nomura as chief risk officer for the Americas and global head of portfolio risk.

He began his career as a senior asset and liability analyst at PNC Financial Services Group, leaving the firm as chief market risk officer for PNC Group in 2004.

“This appointment demonstrates our continued ability to attract top talent to support our mission and further enhance our resiliency as a critical market infrastructure,” said John Davidson, OCC chief executive officer.

Ye replaces former OCC chief risk officer J.J. Fennell who is leaving on 2 July to pursue another opportunity.

“On behalf of our board of directors and management committee, I want to thank J.J. for the many contributions he brought to OCC during his tenure, including our efforts to strengthen OCC’s overall operational resiliency as well as enhancing the efficiency and effectiveness of our enterprise risk management, model risk management, security services, business continuity and third-party risk management teams,” said Craig Donohue, OCC executive chairman.

Ye’s appointment follows a record breaking start to the year for the OCC after it announced it had hit a new record volume for US listed options contracts cleared in 2020.

Despite challenges posed by the pandemic the central counterparty (CCP) cleared 7.52 billion total contracts last year and 7.47 billion options contracts, surpassing the previously set record of 5.24 billion total contracts and 5.14 billion options contracts in 2018.

“As a Systemically Important Financial Market Utility, OCC provides vital stability and risk management to the US listed options markets,” said Scot Warren, OCC chief operating officer.

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Despite challenges posed by the pandemic and remote working conditions the central counterparty (CCP) cleared 7.52 billion total contracts in 2020 and 7.47 billion options contracts, smashing the previously set record of 5.24 billion total contracts and 5.14 billion options contracts in 2018.

“Our performance during 2020’s unprecedented markets underscores how industry utility central counterparty clearinghouses (CCPs) like OCC benefit the investing public by underpinning markets, promoting stability and market integrity,” said John Davidson, chief executive officer at OCC.

In comparison with 2019, the OCC also recorded a massive 51.2 percent increase in the total number of contracts cleared in 2020 and a 52.4 percent increase for options contracts.

Following a year of unprecedented volumes recorded by the OCC, the clearing house finished on a high recording the highest volumes for one month in its history in December.

It stated 756,963,242 contracts were cleared in December, surpassing the previous monthly volume record of 693,042,180 contracts set in June 2020.

In the same month, the clearing house attracted the attention of commodities broker Marex Spectron who became a clearing member of the OCC as part of its plans to expand its equity derivatives clearing business.

Eyes are on European clearing houses to see if they can match the OCC’s example in the coming year following what will undoubtedly be a turbulent period after the UK’s departure from the European Union at the end of 2020.

Eurex confirmed in November that it had extended its CCP Switch Incentive Programme, which waives booking fees entirely for over the counter (OTC) interest rate swaps and overnight index swaps, until June this year after confirming that since the launch of the scheme it had already poached more than 500 banks and buy-side firms for swaps clearing.

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The US regulatory watchdog said the bank had a weak risk management and control framework, including inadequate internal controls and an insufficient audit system, across its fiduciary business for several years. 

These deficient risk management practices led to “unsafe or unsound practices”, the OCC found, and insufficient means to avoid conflicts of interest. The OCC said that JP Morgan denied its findings, but it had consented to the order and had remedied the deficiencies that led to this penalty.

In September, JP Morgan was ordered to pay $920 million, the largest fine on record for its trading activity, after admitting its precious metals and US treasuries trading desks engaged in an unlawful spoofing scheme that spanned eight years.

The bank reached parallel agreements with the US Department of Justice, Commodity Futures and Trading Commission (CFTC), and the Securities and Exchange Commission (SEC) resulting in the record penalty for the illegal trading activity.

In response to the charges, JP Morgan said in a statement that it has entered into a three-year deferred prosecution agreement with the Department of Justice.

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The upgrade will see the OCC’s clearing system provide users with better data submission and reporting functionality, as well as other benefits such as improved control mechanisms, futures processing and product support.

“Following a lengthy and rigorous analysis, we decided to pair our internal work with the adoption of the TRADExpress RealTime Clearing solution,” said John Davidson, chief operating officer at the OCC.

“The new systems will deliver many advantages to our participating exchanges and clearing firms in a modern and flexible technology architecture, including enhanced functionality to procure and submit data to and from the system for external and internal users, enhanced ad-hoc reporting capabilities, enhanced control mechanisms, expanded new product support capabilities, improved futures processing, and greater flexibility in processing clearing member trade agreements.”

Peter Lenardos, CEO of Cinnober, added that the TRADExpress Real Time Clearing system will support the OCC’s efforts to improve business development and time-to-market for new products across the markets they clear.

Cinnober was recently acquired by Nasdaq for $220 million, after increasing its initial bid of around $190 million made in September. A majority of shareholders at Cinnober have approved the new offer, and settlement of the deal is expected to begin on 6 February.

Lars Ottersgard, head of market technology at Nasdaq, told The TRADE at the time the deal was announced that Cinnober has common capabilities as the exchange in many spaces and that Nasdaq’s most significant inhibitor for growth has been capacity to support clients.

“We have had good traction for many years for market technology, which has been growing steadily through the years. We have seen an uptake in interest in our capabilities to deliver solutions both to the wider capital markets and into new marketplaces,” Ottersgard added.

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Davidson, who was previously Citi’s chief compliance officer, will join the US equities clearing house in May following the departure of Michael McClain, who most recently joined DTCC.

“John brings to OCC extensive experience in clearinghouse financial risk management, along with broader knowledge in operations, IT management, enterprise risk management, and compliance,” said Craig Donohue, CEO, OCC.

“He is a very forward-looking, results-oriented leader who will help us deliver on our responsibilities as a SIFMU, including the work we are doing on covered clearing agency rules and SEC Regulation SCI.”

Previously at Citi, Davison led its global compliance team, responsible for identifying, evaluating, mitigating and reporting on compliance, regulatory and reputation risks across its operations.

He took over as chief compliance officer in 2013, with the aim to clean up its operations following accusations of interest rate rigging and spoofing.

Prior to Citi, Davidson spent 12 years at Morgan Stanley, serving as managing director and operations officer for the firm’s global operations and services division. 

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The SEC passed unanimously a vote to bring new standards, such as risk management, to clearing houses that clear equity derivatives and fixed income. 

The vote from the SEC is set to bring the US closer to gaining equivalency from the EU, which would allow US clearing houses to clear trades from European banks.

Without the recognition, European banks would face tougher capital rules for trading and clearing US securities, which was estimated to amount to an additional $5 billion in capital requirements.

“Without such recognition, a CCP cannot admit firms established in the EU to membership. It cannot clear for trading venues established in the EU nor can it clear products subject to the clearing mandate for market participants established in the EU,” stated Craig Donahue, CEO and executive chairman of the Options Clearing Corporation (OCC). 

Donahue also said the risk weighted asset exposure for OCC’s EU affiliate clearing members’ could reach to over to over $75 billion if equivalency was not reached.

“Ultimately, the imposition of punitive capital charges on OCC’s EU-bank affiliate clearing members will trickle down to exchanges and market participants and would adversely impact the entire marketplace,” he added.

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Banks could pull out of listed options markets in the wake of higher capital rules, the Options Clearing Corporation (OCC) has warned.

The Basel III capital rules, or the supplementary leverage ratio (SLR) rules in the US, have caused a number of banks to re-evaluate their derivatives options due to higher balance sheet costs, with many pulling out of certain markets.

“We are starting to see evidence of this evolution with a number of general clearing members (GCM) having already ceased their operations while others are re-assessing their business models,” writes John Fennell, executive vice president of financial risk management, OCC, on the company’s website.

Fennell claims that the current rules do not recognise the “risk limiting effects” associated with being long and short options of different strikes.

“We fear that a further reduction of GCMs (general clearing members) will result in greater concentration risks and a decrease of available balance sheet capacity for clearing of derivatives transactions, including those that are anticipated to become subject to mandatory clearing,” he adds.

The OCC has co-signed a letter with 30 exchanges and trading firms, including Bats, CBOE, ICE, Eurex and Virtu Financial, for regulators to adopt the Standardised Approach for Counterparty Credit Risk (SA-CCR) method to calculate exposure risks for exchange-traded derivatives.

It has also called for an exemption for options market makers from the leverage ratio rules.

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