Comment Text:
1. What is an appropriate working definition of “perpetual derivative?” In addressing this
question, please consider:
a. What characteristics must a product have to qualify as a “perpetual” derivative?
A perpetual derivative must have no expiry date, and should not mature at any time. A swap agreement with no defined end date would be an example of this, as would a futures contract without a defined end date that may be maintained by a spot fee as the price fluctuates throughout the day.
b. Is there a taxonomy of different kinds of perpetual derivatives and what would be
key characteristics in this taxonomy?
The taxonomy would be characterized by the derivative instrument's relationship to the underlying asset, and the obligations of both counterparties as well as their brokers. I would classify them as perpetual futures and perpetual swaps.
Perpetual futures: A contract allowing traders to speculate on the price of an underlying security with no end date. This may include margin maintenance fees per their broker's agreement.
Perpetual swaps: A contract allowing traders to swap the exposure of 2 or more assets with no end date.
c. Are there specific characteristics that distinguish a perpetual futures contract from
other perpetual derivatives?
Yes, a perpetual futures contract can be exercised at any time to realize the value of the contract, but it has no expiration date. This contrasts with perpetual swaps. See above definition.
2. Would Perpetual Derivatives have advantages for market participants over traditional
futures contracts or spot market products? Would Perpetual Derivative products provide
commercial risk management features that cannot be met with existing products?
Perpetual derivatives may provide an advantage for someone who is seeking to maximize return in a short amount of time provided the trade is correct. If a fund seeks the option to buy an asset at any time in the future, they are heavily exposed to the asset despite not being forced to file ownership in detail, potentially obscuring criminal activities from regulators.
3. Would Perpetual Derivatives products pose any unique risks for market participants or the
broader markets? Are there additional protections or safeguards that the Commission or
exchanges should adopt to mitigate risks associated with these products?
These products pose many risks to the broader market and to market participants at large:
1. Transparency
Derivatives of this nature allow bad actors to gain outsized levered exposure to an asset indefinitely while sidestepping reporting requirements. Due to the nature of these contracts, the underlying asset may be reported by the writer of the contract, the owner of the contract will be the party that is exposed to the asset's price fluctuations. This may also present difficulties in determining risk, due to the lack of an expiration.
2. Insolvency Risks
Derivatives of this nature present a significant risk, particularly in the event of the writing party's insolvency. Due to the complexity of the pricing, it may be difficult to determine a price for the contracts or create a market for the product should either party fail to meet their obligations. This can harm market participants with positions in these products, and due to the dynamic hedging strategies often associated with these positions there is a significant capacity to harm market participants who are only exposed to the underlying asset. There may also be ownership issues that arise in the event of a party's inability to meet their obligations.
4. Do the current risk disclosures that futures commission merchants are required to provide
customers, pursuant to Commission regulations, adequate to address risks associated with
Perpetual Derivatives? If not, what additional disclosures should be required to be
provided to customers? I am not familiar with the disclosures provided on these products, but I would imagine most customers, particularly retail investors and traders, are unware of the associated risks and mechanics of these instruments.
5. Do Perpetual Derivatives pose any unique risks if they were to be offered in physical
commodity markets, such as with agricultural or energy commodity derivatives?
I am unsure as commodity markets are not my focus, so I will decline to comment.
6. Do Perpetual Derivatives raise unique concerns about susceptibility to manipulation?
Derivatives of this nature allow bad actors to gain outsized levered exposure to an asset indefinitely while sidestepping reporting requirements. Due to the nature of these contracts, the underlying asset may be reported by the writer of the contract, while the owner of the contract will be the party that is exposed to the asset's price fluctuations. This may also present difficulties in determining risk, due to the lack of an expiration. In the event of a party's insolvency there is risk presented to market participants with positions in these products, and due to the dynamic hedging strategies often associated with these positions there is a significant capacity to harm market participants who are only exposed to the underlying asset. There may also be ownership issues that arise in the event of a party's inability to meet their obligations.
a. Are there additional protections or safeguards that should be adopted by the
Commission or exchanges to mitigate concerns about susceptibility to manipulation
with Perpetual Derivatives?
Perpetual Derivatives should not be available in our markets. Please do not allow Wall Street to lever themselves for an infinite amount of time. These financial innovations often increase market volatility, incentivizes breaking the law, and sometimes result in prolonged market crashes that harm investors (collateralized debt obligations, mortgage backed securities, total return swaps, etc.)
b. Is there any additional guidance the Commission should adopt to clarify the
regulatory treatment of Perpetual Derivatives?
Perpetual Derivatives should not be available in our markets. Please do not allow Wall Street to lever themselves for an infinite amount of time. These financial innovations often increase market volatility, incentivizes breaking the law, and sometimes result in prolonged market crashes that harm investors (collateralized debt obligations, mortgage backed securities, total return swaps, etc.)
c. Would Perpetual Derivatives raise any novel concerns with regard to conflicts of
interest?
Each party is incentivized to manipulate the underlying asset to their favor. The writer of the contract, due to the spot margin maintenance fee structure that is typically employed, is incentivized to move the underlying asset in a way that forces the majority of capital invested (long or short) to pay the maximum spot fee. This is a clear conflict of interest.
7. Do Perpetual Derivatives raise unique surveillance concerns for exchanges listing
perpetual products? Perpetual derivatives are another layer to obscure trading activity from regulators. They also are often traded over the counter, and may not meet the requirements to be listed on traditional exchanges.
8. Do Perpetual Derivatives have the potential to adversely impact the liquidity or usefulness
for commercial risk management purposes of traditional futures market products?
I believe they cater to a different group that is using them for different activities. Splitting participants between traditional and perpetual futures will clearly impact liquidity to a degree, as less capital will be present in traditional futures.
9. Please describe the likely user base for Perpetual Derivatives. Will Perpetual Derivatives
attract the same array of market participants as traditional futures, including commercials,
asset managers, hedge funds, speculators, and others?
I believe that asset managers, hedge funds, and commercial investment firms will be the likely user base. I believe they will be often used as a hedge for high risk bets on the underlying asset, and will be used to obscure asset ownership.
10. Are some traditional futures market participants less likely to participate in Perpetual
Derivatives markets? Will Perpetual Derivatives markets function as effectively and
efficiently if certain traditional participants are less present or if the market is heavily
weighted towards certain types of participants?
Retail traders and investors are unlikely to participate in this market to the same degree as they do in traditional futures. This will not create an efficient market as the price would largely be controlled by asset managers, and retail inflow is the primary source of liquidity introduced to the system aside from quantitative easing.
11. The aims of derivatives markets include price discovery and risk mitigation. How do
Perpetual Derivatives further risk mitigation? How do they further price discovery? Please
provide likely use cases for Perpetual Derivatives.
I do not believe perpetual derivatives further risk mitigation. I believe they are a substantial risk to our markets at large. The use cases have been listed above, they are primarily to hedge risky positions in the underlying asset, hide criminal activity, or avoid triggering reporting requirements in assets which inherently is a lack of transparency.
12. Futures markets can provide arbitrage opportunities between futures and cash markets,
with convergence at expiration being a hallmark of a properly functioning market. What
arbitrage could reasonably be expected between Perpetual Derivatives, traditional futures,
and cash markets? What cash market convergence could reasonably be expected?
The same arbitrage will be present as in traditional futures markets, but the risk is inherently exponentially greater due to the lack of an expiration.
13. Should Perpetual Derivatives be classified as swaps or futures contracts?
They should be classified as their own unique instrument. They may share characteristics with swaps and futures but the lack of an expiration date creates a need to regulate them entirely differently. Please do not allow these to continue being traded.
14. Is a Perpetual Derivative consistent with a traditional futures contract model whereby there
is a specified expiry date, and the price of the contract represents the price of the underlying
commodity at the time of expiry? There is no way for a perpetual contract to be consistent with one who is priced with the expiration date in mind. They serve different functions.
15. Do Perpetual Derivatives increase customer default risk that may expose other customers
to potential losses in the event of an FCM insolvency resulting from the customer default?
As stated above many times, yes. Without a doubt, these are financial weapons of mass destruction.
16. Do Perpetual Derivatives raise unique issues in the event of a futures commission merchant
or derivatives clearing organization insolvency under part 190 of the Commission’s
regulations or the U.S. Bankruptcy Code?
Yes, due to the inherent ownership questions that would follow. In addition to this, the more obvious point is that a fund who has sold naked call options can be liquidated if margin is not maintained. While the price may fluctuate wildly, time to expiry is always a factor in pricing. Without the time factor, a fund may expose themselves to "infinite risk" and that will be passed on to the members of the clearing organization, as well as their shareholders.
Thank you for your time and consideration. I urge you to not allow perpetual contracts in the US markets in the interests of transparency, stability, and the reputation of the US capital markets.
