CFTC’s Global Market Advisory Committee explores increased retail participation in derivatives markets

By Brad Rosen, J.D.

Commissioner Dawn Stump opened the CFTC’s first GMAC meeting of 2021 noting a significant uptick in retail participation in the markets overseen by the Commission and its impact on the global derivative markets. Stump, the GMAC sponsor, introduced the first panel tackling those issues, as well as underscoring the importance of assuring adequate education and protections for the many new entrants to the futures markets. The agenda also included a panel discussion on impact of the COVID-19 pandemic on global clearing. The meeting was held via teleconference in accordance with agency’s COVID-19 social distancing protocols.

Pandemic leads to a resurgence of retail traders. Mel Gunewardena, Chief Market Intelligence Officer and Deputy Director in the Market Intelligence Branch of Division of Market Oversight, explored the retail influence in the derivative markets. Gunewardena observed the number of first-time traders that, fueled by retail interest, reached the highest levels during the early pandemic months. He also noted that increased order flow through retail FCMs and introducing brokers, often offering online account opening, reduced fees, and minimum balance requirements, along with the growth of smaller retail-friendly contracts at existing and new designated contract markets (DCMs), contributed to the growth of the retail market demographic. He also noted:

• Although the number of participants has grown exponentially, the direct trade volumes are approximately 10-15 percent of total activity.
• Asset and money managers offering retail products like exchange traded funds (ETFs) increase direct market impact, while swaps and tangential cross-market arbitrage driven by retail participants drive indirect market impact.
• Physical commodity markets, like silver and crude oil, are much larger than small-cap equities, and while the futures markets have long and short interest that are dissimilar to equities, they are not immune to short-selling type impacts.
• Retail activity adds to liquidity as almost all transactions are placed as resting or limit orders. Retail participation is also positive for liquidity diversification as retail trading strategies differ from those of the professional traders.

The need for greater investor protections and education. Gunewardena also shared one disturbing but not surprising observation: overall, retail accounts between January, 2020 and February, 2021 have had significant negative returns. As a consequence, he noted that more work may be necessary with respect to investor protections, disclosure requirements, suitability standards, and establishing clear obligations that protect investor interests by all introducing brokers and FCMs. Gunewardena also noted the need to evaluate market structure developments and policy considerations in connection with predatory type strategies that leverage or target broad retail engagement.

On this score, GMAC member Gerry Corcoran, the CEO of the FCM R.J. O'Brien, noted the historic role that brokerage firms and market intermediaries have played to protect retail investors in real time. This relates to excessive trading, margin issues, and market understanding generally. Tom Sexton, also a GMAC member and the President and CEO of the National Futures Association explained that investor education is one of the cornerstones of regulation. He pointed to the Futures Fundamentals website, a one-stop educational resource designed to simplify and explain complex market topics to all investors. 

Jonathan Lave, Associate Director, Division of Market Oversight, provided an overview of the Commission’s regulations and core principals related to retail market participants. Meanwhile, Alison Beer, Senior Legal Counsel at Ontario Securities Commission shared some cross-border observations and insights regarding the retail derivatives market and recent events with regard to our neighbor to the north.

Impact of COVID-19 on global clearing. The meeting’s second panel reviewed the impact of the COVID-19 pandemic on global clearing with a focus on margin requirements, clearing volume, and CCP operations. Pedro Gurrola-Perez, Head of Research at The World Federation of Exchanges Ltd. discussed the procyclicality of CCP margin models, noting that systematic problems required systematic solutions. Meanwhile, Nicholas Lincoln, Group Head of Market Risk & Liquidity Risk, LCH Group talked about how the LCH clearing model worked during the pandemic while focusing on two unique use cases. Last, Ulrich Karl, Head of Clearing Services at ISDA took a look at COVID-19 and CCP risk management frameworks from a clearing member perspective. The panel’s undertaking was a continuation of their discussion from the December 2020 GMAC meeting.