FIA chair Crighton calls for segregation of leveraged retail default funds

Speaking at a hearing at the House committee on Agriculture on Thursday, on the reauthorisation of the Commodity Futures Trading Commission (CFTC), Crighton said the rise in leveraged retail investor trading gives rise to change in guidance around default funds. Under the current system losses are mutualised through the default waterfall, with the funds acting as a buffer against the effects of a default.

“A unique aspect of the derivatives ecosystem is that in the event a clearing member defaults, losses are mutually shared by the remaining clearing members in what is known as default fund loss mutualisation,” Crighton, who is also global co-head of futures and head of OTC and prime clearing at Goldman Sachs said in testimony given at the hearing. “With the increase in leveraged retail transactions, clearing members representing institutional end users will now participate in the same default fund as retail investors.

“FIA recommends that Congress consider authorising the CFTC to issue rules or guidance to require that financial resources that would be used to manage the default involving leveraged retail transactions be segregated from other default resources in the clearinghouse. Such separation could mitigate systemic risk concerns and prevent contagion from spreading between retail investors trading novel products and end users and other traditional market participants accessing the markets for hedging purposes.”

The re-authorisation is the CFTC’s first since 2008, and comes at a time when the role of the agency is being enlarged meaningfully to support technological innovation and a push to have oversight of new markets. The Washington-based agency on Wednesday published a list of participants for a new chief executive innovation council to support the effort.

That came after CFTC started allowing certain digital assets, including US dollar-pegged stablecoin USDC to be used as tokenised collateral for derivatives trades on Monday.

The CFTC allowed listed spot cryptocurrency products to start trading on registered futures exchanges last week.

“We support innovation and believe there is tremendous potential in technology to benefit all market participants,” Crighton added. “We also believe there are valuable and time-tested risk management traits of our current market structure that can play an important role in the integration of traditional and novel products and platforms.

“Ensuring risk management goes hand in hand with innovation will ensure the broadest participation across both retail, end users and institutional investors, and the issues I’d like to raise today are to that end.”