Supporting Market Innovations, Managing Industry Risk and Addressing Advancements in the Derivatives Space
“From a Central Counterparty Clearing (CCP) perspective, it is our role to provide stability and certainty behind the trading of a new asset class,” said Options Clearing Corporation (OCC) Chief Risk Officer John Fennell about clearing Cboe’s bitcoin contract. “It is important for OCC to support new asset classes like crypto and ensure we can provide confidence, both financially and operationally, in a manner comparable to existing products we clear.”
Hehmeyer Trading + Investments sat down with OCC’s John Fennell to talk about how OCC supports market innovations, manages industry risk and addresses advancements in the derivatives space.
Fennell started his career at OCC about 25 years ago and has held roles in operations and technology before transitioning into a risk management position. He has spent the last 15 years looking at how the industry and OCC manages risk.
“I find the derivatives industry very innovative and stimulating,” he said. “For example, options traders and market participants needing liquidity created box transactions as a substitute for obtaining securing financing.”
In the late 90’s and early 2000’s, traders began taking these risk- neutral positions, effectively buying deep in and out-of-the-money calls and puts that OCC would clear.
“The carry rate incorporated in the option prices would be comparable to financing rates with the options being used to obtain the central counterparty guarantee, making the loan attractive from a credit perspective,” he said about how options traders look at challenges and come up with innovative solutions. “It’s OCC’s role to support these solutions and manage the risk.”
When it comes to managing risk on cryptocurrencies, Fennell believes that it is important for OCC to look at new asset classes from an operational and financial perspective.
“When we were preparing to clear bitcoin, we looked at price volatility and if our risk models were robust enough to sufficiently predict potential risks,” he said. “We did a lot of back-testing on our margin models to make sure we could manage the price volatility.”
Fennell spoke more in depth about his role at OCC.
“My role is to ensure we have a framework that allows OCC to identify, measure, monitor and manage events that could keep the firm from achieving its clearing objectives, whether that be to manage credit, market and liquidity risks or identify areas of operational vulnerability within the firm and as an industry,” he said.
As Chief Risk Officer (CRO), Fennell oversees various departments at OCC including; Information Security, Enterprise Risk, Model Risk Management, Third Party Risk Management and Business Continuity.
“At the top of the list for all CROs is cyber risk. We are all interconnected as an industry and if a bank or CCP has a weakness in their infrastructure it can impact everything,” he said. “Industry groups, market participants and the government work together on this subject to combat cyber risk and develop a strong financial eco-system.”
Fennell also talked about challenges the industry faces that stem from the 2008 financial crisis.
“We have seen a lot of great regulation to protect against future crisis’ but we have also seen unintended consequences,” he said. “For example, bank capital requirements related to derivatives transactions have proved punitive. They translate into massive capital requirements on banks for otherwise risk-neutral positions associated with market makers. From a systemic risk perspective, we have to ask, does the industry have the capital reserves to absorb a disruption while continuing to comply with these punitive capital requirements?”
Fennell said that OCC regularly speaks to regulators about this and has seen change in the proposed rules coming out from the Federal Reserve that, if approved, would work to ensure sufficient capacity is in place. He also said that OCC has adopted many changes to cover any defaults in the future.
“We have extended our Guarantee Fund to house resources that would cover not only the default of our largest clearing firm, but also the second largest clearing firm,” he said.
Leadership and Team Development
In closing, we asked Fennell about a piece of advice that has helped him throughout his career.
“You can’t be promoted until someone is able to take your place,” he said. “That alone may not seem interesting advice but if you think about it in terms of continually building your team and giving team members growth opportunities, it makes more sense and reflects positively on you as a leader.”
We also asked him if there is one person he could go to coffee with, dead or alive, who would it be?
“Abraham Lincoln,” he said. “He was able to manage his insecurities with his confidence in his own abilities, and surround himself with his competitors to do great things in history.”
As the industry evolves and adapts, it is important for organizations to look at the big picture and identify areas of vulnerability. While innovation is good for the derivatives space, it is in working together to manage risk that will make for a stronger eco-system.