As we countdown to the launch of bitcoin futures trading on the CBOE (10 December) and CME (18 December), the big banks – via the Futures Industry Association - have suddenly got cold feet about the risks. We don't blame them, somebody's going to get hurt, the only question is who. The banks are worried it could be them. The FIA’s “primary” members include all of the usual suspects like JPM, Goldman, Citi, Bank of America, Morgan Stanley, etc. The risk they are most concerned about relates to clearing houses which, ultimately, they stand behind. The problem, of course, boils down to Bitcoin’s volatility, something we flagged after the CME announced circuit breakers early last month.
Having taken a gamble on bitcoin futures, which are set to begin trading by the end of the year, the CME is now seeking to avoid the consequences of what has emerged as both the cryptocurrency's best and worst selling point: its unprecedented volatility…While the CME already uses daily vol limits on most other markets, including crude, gold and market futures, to temporarily halt trading when price swings get out of control, the CME has never before dealt with something like bitcoin
In June, Bloomberg showed how Bitcoin’s 30-day volatility had risen to 100%, which was comparable (at the time) with one of the most volatile financial instruments they (and we) could probably think of - a three-times levered ETF in junior gold miners.
The CME has proposed three trading limits for Bitcoin futures, 7%, 13% or 20% up or down from the previous day’s closing price. The first two thresholds, for 7% and 13% moves, are “soft” limits, which would trigger a two-minute pause in trading of bitcoin futures. The 20% limit would be a hard stop after which trading would be halted. In the first ten months of Bitcoin trading in 2017, Coindesk calculated there had been 69 days in which Bitcoin moved at least 7%, 11 days in which it moved 13% and two days in which it moved 20%. In fact, we had another 20% intra-day move on 29 November 2017.
As the Financial Times reports, the banks – via the Futures Industry Association – is sending a letter to the CFTC which it will publish today.
The world’s largest banks are pushing back on the introduction of bitcoin futures, raising concerns with US regulators that the financial system is ill-prepared for the launch of the contracts as the value of the volatile cryptocurrency has soared. On Wednesday, the price of bitcoin climbed to a fresh record high of more than $14,000. Institutional investors have been keen to trade the asset but only via a regulated market.
However, the planned launch in the next 10 days of futures contracts by the Chicago exchanges CME Group and CBOE Global Markets, given a green light from the Commodity Futures Trading Commission last week, has prompted a backlash among the major brokers who backstop trading across the industry. The Futures Industry Association, the main futures industry lobby group, plans to send a letter to the CFTC that will be published on Thursday.
We could be forgiven for thinking this is all very “last minute”. The CME announced its launch of Bitcoin futures trading back in October and had been canvassing opinion from market participants, including the banks, for months beforehand. The FT confirms that it was seen a draft of the FIA’s letter in which the latter states that the introduction of Bitcoin futures “did not allow for proper public transparency and input”. This is self-evident, resulting from the launch of futures trading contracts being fast-tracked by all parties after Bitcoin’s price rose parabolically this year. As part of this fast track process, the CME and CBOE adopted a “self-certified regime” for the contracts, meaning that the normal regulatory oversight didn’t take place. As the FT notes, the FIA is belatedly calling for a review.
Using it (self-certified regime) for “these novel products does not align with the potential risks that underlie their trading and should be reviewed”, the draft reads. The CFTC warned last week during its approval process that the emerging cryptocurrency markets were largely unregulated and the agency had “limited statutory authority”. “It is also our understanding that not all risk committees of the relevant exchanges were consulted before the certification to launch these products,” the letter added.
Getting into the “nitty gritty”, even though the banks have been discussing the specification of the contracts for about six months (according to the CME), as the moment of truth approaches, they’ve “zeroed in” on the fragility of clearing houses. With so much Bitcoin trading occurs on other exchanges and outside the hours of CME/CBOE (even if they trade Sundays), the banks have realised their vulnerability.
Futures brokers are worried they will bear the brunt of the risk associated with bitcoin futures, because the margin that backstops the contract is placed in a clearing house. Clearing houses stand between two parties in a trade, managing the risk to the rest of the market if one side should default. They are mutually funded in part by banks to guard against the failure of their largest members. Several brokers among the top 10 largest providers have privately confirmed to the Financial Times that they will not clear the products immediately.
One clearing broker said that it would be open-minded about cryptocurrencies, as they were US dollar products, but only if they were “properly controlled and regulated”. However he added: “We’d still be on the hook in a worst-case scenario as we are exposed as members of the clearing house.”
Sometimes “old heads” are useful in these circumstances. Speaking on Bloomberg TV, Royal Bank of Scotland Chairman, Howard Davies, said he would advise the CME and CBOE against launching Bitcoin futures.
"I’m not quite sure that they know enough about what the underlying is, about the nature of the supply and demand of the underlying. I think it would be a very risky move for them in reputation terms. This is irrational exuberance. This is a very, very unusual market, that shows we’re not in a normal two- way trading market. Blockchain is much more interesting. The idea of a distributed ledger, which makes transactions and payment systems much cheaper and faster in real time is a good one. Blockchain, I think, has got life in it.”
Thomas Peterrfy, the founder, Chairman and CEO of Interactive Brokers (the one who fronts the company’s slightly irritating TV ads) is one of the “giants” of electronic trading in US financial markets. The FT noted Interactive Brokers' stance.
”Thomas Peterffy, a pioneer of electronic trading and head of Interactive Brokers, has warned that the introduction of bitcoin futures into a clearing house could increase systemic risk. On Wednesday Interactive said its clients would be unable to short the bitcoin futures market because of the extreme volatility of bitcoin.
It looks like the banks have realised Peterffy might be right in limiting trading of Bitcoin futures.