Comment Text:
Thank you for the opportunity to comment on the topic Impact of Affiliations of Certain CFTC-Regulated Entities. Though I sincerely appreciate the opportunity, I doubt very much that my comments will be seriously considered. I endorse the viewpoint expressed by Chairman Christy Romero in her statement, which can be accessed at the following link: https://www.cftc.gov/PressRoom/SpeechesTestimony/romerostatement062823.
Vertically integrating firms that should have competing interests would obviously further entrench the de facto monopoly/cartel that already exists in conflict with what is the public interest and the protection of investors. It's clear that every large firm in our current market structure has their own financial interests directly opposed to the majority of their clients, most of which have no real choice but to use their services if they wish to access the "market," which is in fact more like a casino. With these unwilling customers forced to put their own interests and protection in the hands of firms trading for their own interest, and often taking the other side of their trades, or in the hands of firms taking considerable fees from those very same participants, or a clearing firm run by those participants. Nine times out of ten all three, at least. A market simulated in the dark in the back pocket of the largest firms with leadership control over the clearing house (as through the owner-member Board of Directors of the DTCC), associated\owned\subsidiary funds trading for profit against them in the market, and inducement contracts with customer facing brokers (sometimes providing almost half their revenue through payment for orders alone) where anything that can be unreported, internalized, and offset will be, and with minimal enforcement and oversight.
It is no surprise that firms prioritize their own financial interests, as their fiduciary duty is to their owners and shareholders, but removing competition and oversight, and expecting them to balance their own fiduciary duty with the competing objectives of investor protection and public interest for no real benefit is a farcical idea. Much less entrusting to them the protection of investors and to work in the public interest. The trust we already place in these firms is improper, especially given our centralized market structure focused around the "Maker-Taker" price model and high frequency trading. It's impossible for those interests never to come in to conflict in the market, and a monopoly or cartel solidifies the profit interests of anyone within the monopoly or cartel against those without. The only possible check is keen regulatory oversight with strict standards for all participants, and power of the outside stakeholders to influence operations of the monopoly. Both are sorely lacking in our current, and the proposed, framework.
It allows bad actors to push their leverage and risk as far as the clearing firm will allow. Use their influence over the clearing firm to exercise the clearing firm's discretion to allow them that leverage until it becomes an existential issue and risk for the clearing firm itself. Then because the clearing firm guarantees both sides, use that existential threat for even more discretion, and to avoid sensible margin and collateral requirements. Leveraging the clearing firm's extensive access to various credit and liquidity facilities and willingness to use their discretion to take extraordinary preferential measures (like simply looking the other way, and ignoring margin requirements despite the risk) to safeguard against that risk to the member firm's benefit. Hedging the member firm's risk while exposing the public, the clearing firm itself, and the entire market to significant default and systemic market risk (should the member firm default, leaving the clearing firm its obligations through responsibility for that default, and through cascading failures proceeding from the default and possible liquidations).
For examples of this risk pattern playing out see the FTX collapse, or the billion dollar margin shortfalls at the DTCC/NSCC and OCC for the January 2021 period in their quantitative backtesting. For another example of a similar pattern of voracious risk taking, margin safeguards failing and that resulting in an existential threat see the Archegos incident, and the following Credit Suisse report on the incident and collapse/merger. Further vertically integrating our centralized market structure weakens the entire system to these sort of threats and risks, as without strict oversight, consistent standards, and disclosure firms are incentivized to look the other way, and once these risks are out of control continue the course and avoid any remedial measures in an ill advised attempt not to rock the boat ("preserve stability") and avoid further losses.
The proposed vertically integrated market structure eliminates competition and puts the power in the hands of a sole entity. This is a cause for concern, as competition is necessary for the market to self-regulate to the degree that it is able. The lack of regulatory oversight, competition, or disciplining effect means that as much risk can be taken as desired by the new vertically integrated system, with no ability by outside entities to intervene or set risk limits. Risk to the operating firms is not enough if they are empowered to obscure that risk and waive any prudential requirements. This is an ill-advised and potentially disastrous market environment.
The risks associated with the proposed vertically integrated market structure are further compounded by the fact that it mimics the market structure in the unregulated crypto space, which has significantly less protections for investors. As Chairman Romero has pointed out, the risks associated with conflicts of interest in such a structure can lead to cascading losses and contagion risk.
In conclusion, the proposed regulatory framework for a vertically integrated market structure should not be implemented in any fashion. It only serves to hand over more power to clearinghouses, eliminate their competition, and allow them to make more money through poor trade fulfillment and questionable margin requirements or structure, at the expense of additional risk, contagion, and cascading losses that investors and customers will ultimately bear.
