Technology. Cybersecurity.
Two buzzwords that are firmly entrenched in the financial lexicon – certainly in equities and options markets, among others.
Craig Donohue, Executive Chairman and Chief Executive Officer at the Options Clearing Corporation took some time to sit down with Traders Magazine editor John D’Antona Jr. and discuss the state of the options industry, covering topics such as volume, OCC’s move to more cloud-based technologies and his greatest regulatory concern.
What follows is an edited version of the conversation:
Talk a little bit about the state of the options industry.
We've certainly seen in the last three to four years a leveling off of volume growth, even as 2017 volume rose by three percent. We’ve had a 45-year industry track record of very significant growth year after year. Investors have become more familiar with and adept at using options, both at the retail and the institutional level. There has also been tremendous product innovation and extension over that 45 years, which is reflected by the recent launch of bitcoin derivatives.
About three to five years ago, we started to see options volumes flatten out from a growth perspective. That can mostly be attributed to the increased cost of capital that are affecting both proprietary traders and large bank-owned broker dealer FCMs who are active in the options industry. And I think the additional regulatory burdens as well.
Is there a single area where you see growth or potential growth?
The growth areas for us as an industry, and because we're the sole clearing house for the U.S. listed options industry, have been in ETF options and stock loan clearing. We’ve seen growth in futures clearing as well, where we clear not only the VIX and variance futures contracts traded on the CBOE futures exchange but also the Nasdaq energy product. And in 2017 we became the first clearinghouse to clear bitcoin futures.
Let's talk about the state of the clearing industry. Can you elaborate on what you're doing there in terms of either technology or new initiatives?
We're undertaking a significant effort to build or buy the next generation of clearing technology at OCC. We presently use a proprietarily developed platform called Encore, which after 20 years is reaching the end of its useful life. We're going through a process right now to determine what our business requirements going forward are for that platform. -We're likely to look at a combination of buy and build. Effectively what we're trying to do is take advantage of more modern and modular technologies that will allow us to lower our long-term cost base. This is a project that we'll be undertaking for the next two to three years, and the hope is that it will make us more agile while helping us reduce our operating expenses.
When we talk about technology, I have to ask if you’re examining anything like a distributed ledger (blockchain) technology or something along those lines? Or is it other technological innovation?
We'll certainly look at distributed ledger concepts in part of what we do, but for the most part we're looking for cloud-based technologies and moving away from mainframe GB2 to more modern technology.
Expounding on the technology theme, are you concerned about some of the new technologies out there? Do some of them expose the market to some kind of systemic risk to the system? Or do you see all technology as a benefit to the system?
Technology is enabling us to accomplish initiatives and tasks much more efficiently and less expensively, with a higher degree of security then we have had in the past. Like other financial institutions and organizations, we're focused on cyber resiliency and cyber security. It’s important to embrace new technology, and to think about how to incorporate it in a way that is protective of the financial infrastructure here in the United States.
Financial technology is an important part of innovation, growth and efficiency for the industry. We have to adapt, and figure out the right ways to do so.
Previously you stated that OCC was looking at a two- to three-year initiative in terms of beefing up its systems. Is there one technology in particular that is particularly attractive? Would it be moving to the cloud or is it something else? Or are you just really in the preliminary stages of opening your investigation?
We're in the early stages but we're definitely contemplating greater use of cloud-based technologies as they will offer us more efficiency, lower cost and probably to some degree, enhanced security. But mostly we're looking for more modern modular technology components right now. Our Encore platform is a large mammoth platform that does everything for us. So, naturally it has become a more complex and expensive to operate system. Also, clearing technology itself has become more widely available than ever before. Twenty five years ago most central counterparty clearing organizations were building their own proprietary technology. Today, there are a variety of different providers of that technology where a lot of that functionality has become more commoditized.
For us it will probably be a combination of buy and build. For example, there will be modular components in the risk area where we probably will build some of what we’re going to be using because it better suits our risk management needs. And there will be other areas where we won't necessarily feel that we can add much value by building it ourselves versus acquiring it and integrating it into our overall IT environment.
What is your biggest concern on the regulatory front in terms of market structure?
I would say right now the biggest concern is bank capital requirements. Most of our clearing members firms are bank-owned broker dealer FCMs, and the banking capital rules are really designed in a way that we would describe it as risk insensitive. So, banks are required to calculate effectively their risk weighted assets. When it comes to client clearing on an agency basis, it just multiplies unnecessarily the amount of bank capital that is required to be held by our clearing member firms in ways that are now impacting trading activity ,volume and liquidity in the listed options market. , This is something that we've been working very hard with the exchanges, clearing members and liquidity providers to try to address with banking regulators. But the concern is that the cost of capital for banks and the agency clearing brokerage business has become so high that during more volatile times it could have the effect of really limiting liquidity in the marketplace. From a market structure perspective, this is probably my largest concern.