Comment Text:
I. Introduction
The recent collapse of Archegos Capital Management and its ripple effects - including the failure of Credit Suisse and its absorption by UBS - highlight systemic vulnerabilities in derivatives markets. These events underscore the urgent need for proactive oversight to ensure accountability, transparency, and stability. The CFTC’s inquiry into perpetual derivatives is timely, as these instruments may exacerbate risks if left unchecked. Below, I address key questions raised in the RFC while advocating for safeguards to protect markets and participants.
II. Defining Perpetual Derivatives
1. What is an appropriate working definition of “perpetual derivative?”
A perpetual derivative is a financial instrument that continuously benchmarks its value to an underlying asset without a fixed expiration date, settling obligations (e.g., margin payments) in real-time or at frequent intervals. Key characteristics include:
No expiration date, eliminating the need for contract rollovers.
Continuous price alignment with the underlying asset.
Ongoing margin/resettlement obligations, creating indefinite counterparty exposure.
Distinguishing Features: Unlike traditional futures, perpetual derivatives lack a maturity date, which obscures long-term risk assessment and incentivizes short-term speculation over hedging.
III. Risks and Regulatory Gaps
3. Unique Risks of Perpetual Derivatives
Systemic Risk: Perpetual derivatives enable unchecked risk accumulation, as seen in Archegos’ opaque swaps. Without expiration, positions can grow exponentially, threatening market stability.
Liquidity Mismatches: Frequent margin calls may strain participants during volatility, cascading into broader liquidity crises.
Manipulation Susceptibility: Real-time pricing and indefinite duration could facilitate “wash trading” or spoofing (e.g., artificially inflating/deflating benchmarks).
6. Manipulation Concerns
Recommendation: Mandate real-time position reporting and limit speculative leverage ratios.
Conflict of Interest: Market makers with perpetual derivative exposure may prioritize proprietary gains over client interests.
15. Customer Default Risks
Perpetual derivatives’ indefinite nature increases default risks, as positions could compound losses beyond collateral coverage. Clearinghouses and FCMs must enforce stricter initial margin requirements and stress testing.
IV. Market Integrity and Accountability
2. Advantages vs. Risks
While perpetual derivatives offer operational efficiencies (e.g., no rollover costs), their structural novelty demands rigorous safeguards. The Archegos collapse exemplifies how lax oversight of complex instruments can destabilize institutions and harm retail investors.
7. Surveillance Challenges
Exchanges must adopt AI-driven surveillance to detect anomalies in perpetual derivative trading patterns, such as abnormal volume spikes or concentrated positions.
13. Classification as Swaps or Futures
Perpetual derivatives should be classified as futures to ensure they fall under the CFTC’s established oversight framework, including position limits and speculative accountability.
V. Recommendations
To mitigate risks and uphold market integrity, the CFTC should:
Close Regulatory Loopholes: Reject no-action letters (e.g., CFTC Letter 25-12) that permit firms to evade margin/clearing requirements for legacy swaps. Institutions like UBS must honor obligations from acquired entities (e.g., Credit Suisse) to prevent moral hazard.
Enhance Transparency: Require real-time public reporting of large perpetual derivative positions.
Strengthen Capital Buffers: Impose higher margin requirements and leverage limits on perpetual derivatives.
Mandate Stress Testing: Ensure FCMs and clearinghouses model extreme scenarios, including prolonged market dislocations.
Retail Protections: Ban perpetual derivatives for unsophisticated investors and enhance risk disclosures.
VI. Conclusion
The Archegos-UBS-Credit Suisse debacle is a stark reminder that innovation without accountability jeopardizes market stability. Perpetual derivatives, while innovative, demand proactive regulation to prevent concentrated risks and protect participants. By closing loopholes, enforcing transparency, and prioritizing systemic safeguards, the CFTC can uphold its mandate to foster fair, competitive, and resilient markets.
