Financial Markets Group - Federal Reserve Bank of Chicago

UK Pension Market Stress in 2022—Why It Happened and Implications for the U.S.

June 2023
by Ketan B. Patel and Santiago I. Sordo Palacios

A steep increase in British sovereign yields and swap rates and an equally steep drop in the value of the British pound (GBP) in September 2022 put substantial liquidity pressures on United Kingdom pension funds. This repricing in risk assets was triggered by the UK chancellor’s mini-budget announcement on September 23, 2022, which led to reactions from market participants. The structure and investment strategies of pension funds made them particularly ill-prepared to deal with market turmoil.

What Does the CDS Market Imply for a U.S. Default?

April 2023
by Luca Benzoni, Christian Cabanilla, Alessandro Cocco, and Cullen Kavoussi

As the debt ceiling episode unfolds, we highlight a sharp increase in trading activity and liquidity in the U.S. credit default swaps (CDS) market, as well as a spike in U.S. CDS premiums. Compared with the periods leading up to the 2011 and 2013 debt ceiling episodes, we show that elevated CDS spreads in the current environment are partially explained by the cheapening of deliverable Treasury collateral to CDS contracts. We infer the likelihood of a U.S. default from these CDS premiums, and estimate an increase in the market-implied default probability from about 0.3–0.4% in 2022, to around 4% in April 2023, which is lower than it was in July 2011 and about where it was in October 2013. Finally, we document changes in Treasury bills trading activity as market participant update their expectations for a U.S. default.

2022 Financial Markets Group Fall Conference–Recap

February 6, 2023
by Nahimoy Alvarez, Nomaan Chandiwalla and Alessandro Cocco

This blog post summarizes the annual Fall Conference of the Financial Markets Group at the Federal Reserve Bank of Chicago, held on November 16, 2022. The conference featured Commissioners Kristin N. Johnson and Christy Goldsmith Romero from the U.S. Commodity Futures Trading Commission, Lamont Black, professor of finance at DePaul University and former Federal Reserve Board economist, and Klaus Löber from the European Securities and Markets Authority. This year’s event took place a week after the collapse of the cryptocurrency exchange FTX, providing a timely opportunity for discussion of the potential spillover risks into traditional finance, existing opportunities and risks in digital assets, and key regulatory tools in place or under consideration to address systemic risks and strengthen consumer protections going forward.

Distributed Ledger Technology, Carbon Accounting, and Emissions Trading

November 2022
by Alessandro Cocco, Jesse Leigh Maniff, David Rodziewicz, Michael Warner

The reduction of carbon emissions is a critical part of the transition to a more sustainable economy. Reducing carbon emissions is expected to lead to fewer natural disasters, lower energy transitions risk, and a lower impact on financial risks resulting from physical damage caused by climate change.

The Impact of Covid-19 Related Policy Responses on Municipal Debt Markets

September 2021, Revised August 2022
by Robert Bernhardt, Stefania D’Amico, Santiago I. Sordo Palacios

Municipal (muni) bonds are an important source of funding for state and local governments. During the Covid-19 pandemic, muni debt markets became severely distressed. In response, the Federal Reserve established the Municipal Liquidity Facility (MLF). Meanwhile, Congress enacted extensive ﬁscal measures that included direct aid to cities and states. To understand whether and how these policies worked, we employ a state-level regression model to estimate the relative eﬃcacy of monetary and ﬁscal policy interventions for the term structure of muni-Treasury yield spreads. We ﬁnd that ﬁscal and monetary policy together reduced those spreads by as much as 225 basis points. Fiscal policy contributed at least twice as much as monetary policy to the notable decline in shorter-term muni-Treasury spreads. At longer maturities, the contribution of ﬁscal policy was at least three times as large as that of monetary policy, suggesting that it addressed fundamental credit concerns.

The Misleading Notion of Notionals—Why Market Value Might Be a More Meaningful Measure in the Treasury Futures Market

June 2022
by Ketan B. Patel

The world’s communities and economies are already feeling significant effects from global warming and related climate and extreme weather events, as the latest United Nations Intergovernmental Panel on Climate Change (IPCC) world climate report published in August 2021 makes clear. In some industry sectors, such as insurance and energy, financial market tools have been developed specifically to mitigate the risk of financial loss related to climate. Such tools have yet to be developed for the U.S. mortgage market—one of the world’s largest at roughly $11 trillion as of the end of 2020.

The Customer Settlement Risk Externality at US Securities Central Counterparties

May 27, 2022
by Sam Schulhofer-Wohl

The architecture of securities clearing and settlement in the United States creates an externality: investors do not always bear the full cost of settlement risk for their trades and can impose some of this cost on the brokerages where they are customers. When markets are volatile and settlement risk is high, this externality can result in too much or too little trading relative to the efficient level, because investors ignore trading costs, while brokerages may refuse to allow investors to trade. Both effects were evident during the volatility in GameStop stock in 2021. Alternative approaches for clearing customer trades that are used in derivatives markets would eliminate the externality. We examine the potential benefits and costs of different approaches for clearing customer securities trades.

CFTC Roundtable Discussion on Non-intermediation

May 25, 2022

Robert Steigerwald, Senior Policy Advisor, Federal Reserve Bank of Chicago, moderated a roundtable discussion hosted by the Commodity Futures Trading Commission (CFTC) that debated the impact a non-intermediation model could have on derivatives clearing organizations (DCOs), and on derivatives trading and clearing overall. Following are some of the participants who participated in this roundtable discussion: DCOs, future commission merchants (FCMs), FCM customers, end-users academics, proprietary traders, and others.

Market Risk in UST Securities and Futures: How Much Did Volatility Increase in March of 2020 Through the Lens of Filtered Historical Simulation Value-at-Risk Models?

May 2022
by Ketan B. Patel

Market volatility increased substantially in March of 2020 as financial market participants reacted to the risk of Covid-19. Even the market for U.S. Treasury securities, long considered a safe haven and one of the most liquid debt instruments in the world, experienced large swings in volatility. In this policy discussion paper, I demonstrate that as volatility increased, model estimates of the market risk increased as well.

What Will It Take to Remove All Lead Service Lines? Common Barriers to Getting the Lead Out of Drinking Water

May 2022
by Cindy Hull, Nathan Anderson

Despite evidence that there is no safe amount of lead exposure in drinking water, there’s still work to be done to replace lead service lines (LSLs) in many American communities. What holds back progress, and what will it take to remove all LSLs? Staff at the Chicago Fed found two common barriers: the split ownership structure of LSLs and the resulting coordination challenges, and a lack of clear financial benefits for those who have the power to replace LSLs. Cities with full LSL replacement programs (Flint, MI, Benton Harbor, MI, Madison, WI, Galesburg, IL, Newark, NJ) offer lessons on how to overcome these barriers and enable a faster pace of replacement.

Fourth Annual Joint Conference of the Deutsche Bundesbank, European Central Bank and Federal Reserve Bank of Chicago on CCP Risk Management

March 22, 2022

On 22 March 2022 the European Central Bank (ECB) hosted the fourth annual joint conference of the Deutsche Bundesbank, the ECB and the Federal Reserve Bank of Chicago on CCP Risk Management. In light of the ongoing Covid-19 pandemic, this year’s conference was held virtually. The event, by invitation only and held under Chatham House Rules, brought together participants from industry, regulatory bodies and academia to discuss expanding access to central clearing and climate change risk in financial markets. The program and relevant recordings are linked in this summary.

Getting the Lead Out: New Opportunities and Challenges to Scale Up Lead Service Line Replacement

February 2022
by Nathan Anderson, Cindy Hull, Steven Kuehl, Suchi Saxena

An estimated to 12 million lead service lines (LSLs) supply water to homes in the United States, potentially exposing people to lead and endangering their health. For children, the consequences are even worse. Although the only way to eliminate lead exposure from LSLs is to replace them with new pipes, replacement has been slow, sporadic, and typically occurred in response to a lead-contamination crisis. New funding and recent changes to laws may spur proactive rapid replacement, presenting new economic and financial challenges. Given the critical nature of this issue, especially in the Upper Midwest, staff at the Federal Reserve Bank of Chicago are working to advance understanding, as well as analyze potential solutions.

Eighth Annual Central Counterparties Risk Management Conference—A Summary

January 31, 2022
by Nomaan Chandiwalla

On October 19, 2021, the Financial Markets Group of the Federal Reserve Bank of Chicago hosted its eighth annual Central Counterparties (CCP) Risk Management conference. The event featured a panel of experts discussing the U.S. Treasury market structure and a fireside chat with Commissioner Allison Herren Lee of the U.S. Securities and Exchange Commission (SEC). This blog post summarizes the discussions.

Bank Exposure to Commercial Real Estate and the Covid-19 Pandemic

November 2021
by Kyle Binder, Emily Greenwald, Sam Schulhofer-Wohl, Alejandro H. Drexler

The Covid-19 pandemic had an immediate and substantial impact on the commercial real estate (CRE) market—emptying workplaces, shopping centers, and hotels, thus affecting the cash flows of businesses occupying commercial space and in turn the ability of commercial space owners to meet their debt obligations.

Managing Climate Risk in Mortgage Markets: A Role for Derivatives

October 2021
by Ketan B. Patel

The world’s communities and economies are already feeling significant effects from global warming and related climate and extreme weather events, as the latest United Nations Intergovernmental Panel on Climate Change (IPCC) world climate report published in August 2021 makes clear. In some industry sectors, such as insurance and energy, financial market tools have been developed specifically to mitigate the risk of financial loss related to climate. Such tools have yet to be developed for the U.S. mortgage market—one of the world’s largest at roughly $11 trillion as of the end of 2020.

Fireside Chat with SEC Commissioner Allison Herren Lee and Maggie Sklar

October 2021

Securities and Exchange Commissioner Allison Herren Lee shares her views on a wide-ranging set of market structure issues with Maggie Sklar, Senior Policy Advisor and Director of International Engagement, Federal Reserve Bank of Chicago.

What’s the Potential Impact of Force Majeure Claims on Financial Stability?

September 2021
by Alessandro Cocco

This article examines the potential aggregate impact on financial stability of several bilateral force majeure claims filed at approximately the same time in one or more markets. One and a half years after the pandemic started, I take stock of the developments involving force majeure claims thus far, and conclude that the likelihood of these claims creating a systemic threat to financial stability is low.

Is a Treasury Clearing Mandate the Path to Increased Central Clearing?

June 2021
by Marta Chaffee and Sam Schulhofer-Wohl

Following stresses in the market for U.S. Treasury securities in March 2020, several observers suggested that increased central clearing of Treasury transactions could help the market function better and called for investigating the costs and benefits of a clearing mandate. This post argues that the effectiveness of a clearing mandate is unclear absent broad changes in the design of the Treasury market. Additionally, the changes in market design necessary to facilitate a clearing mandate could increase clearing even without a mandate. Analysis of the costs and benefits of expanded clearing therefore needs to consider the specific costs and benefits of these broader changes.

Clearing: Perspectives on Industry Developments and Learnings From the Covid Crisis

June 2021
by Ketan B. Patel

LaSalle Street hosts a discussion with executives representing exchanges, swap dealers, clearinghouses and asset managers on the impact of the Covid crisis and what to watch for as the pandemic eases.

Third Annual Joint Conference of the Deutsche Bundesbank, European Central Bank and Federal Reserve Bank of Chicago on CCP Risk Management

March 2021

Financial leaders from around the world gathered for the Third Annual Joint Conference on CCP Risk Management organized by the Deutsche Bundesbank, the European Central Bank, and the Federal Reserve Bank of Chicago. Over the course of the day, speeches, fireside chats, and panel debates grappled with the pressing issues facing the financial sector. They addressed the industry’s response to COVID-19, climate change risk in financial markets, and ongoing structural changes in clearing.

Externalities in Securities Clearing and Settlement: Should Securities CCPs Clear Trades for Everyone?

March 2021
by Sam Schulhofer-Wohl

The architecture of securities clearing and settlement in the United States creates an externality: Investors do not always bear the full cost of settlement risk for their trades and can impose some of these costs on the brokerages where they are customers. When markets are volatile and settlement risk is high, this externality can result in too much or too little trading relative to the efficient level, because investors ignore trading costs but brokerages may refuse to allow investors to trade. Both effects were evident during the recent volatility in GameStop stock. Alternative approaches for clearing customer trades that are used in derivatives markets would eliminate the externality. I examine the potential benefits and costs of different approaches for clearing customer securities trades as well as implications for the U.S. Treasury market, where there have been calls to investigate the costs and benefits of expanded clearing of customer trades, and the relationship to faster equities settlement.

“YOLOing the Market”: Market Manipulation? Implications for Markets and Financial Stability

March 2021
by Maggie Sklar

Since the start of the Covid-19 pandemic in 2020, retail investors have increasingly participated at higher rates in the U.S. equities markets, particularly in day trading and short-term trading. In January 2021, amid a surge of online postings and interest by retail investors who use free trading apps, GameStop stock began moving up and down by billions of dollars a day—resulting in big gains for some investors and billions in losses for others. To the extent the proliferation of free trading democratizes the market, increases the diversity of participants able to participate in the market, and contributes to vibrant and healthy markets, this activity has positive benefits. These recent developments pose new questions for policymakers, such as whether the ability for users to gather together on social media and move the price of a financial product—for reasons unrelated to market news or market fundamentals—is a larger vulnerability, whether this activity fits into tools to prevent or stop market manipulation or not, and if there is a gap in regulatory ways to address such activity.

Climate Change Risk in Financial Markets: Advancing the Conversation in 2021

January 2021

The Federal Reserve Bank of Chicago’s Financial Markets Group opened 2021 with a conversation on climate change risk in financial markets. Panelists representing diverse perspectives discussed the following: How has climate change risk impacted global financial markets to date, and what can we expect moving forward? What are some of the key developments to watch out for—in terms of technology, investing practices, new guidance, etc.? What role can financial markets and the public sector play in better managing this risk moving forward? What are some of the strengths of and opportunities for existing efforts?

Treasury Market Structure Podcast

January 2021
By Alessandro Cocco and Sam Schulhofer-Wohl

In this episode, experts from industry, academia, and government discuss the operations of and recent stresses in the U.S. Treasury market. This market has a huge impact across the financial system—from determining the borrowing costs for governments to serving as a key benchmark within the financial system to helping to keep credit flowing to people who need it.

Can Central Counterparties (CCPs) Use Improved Buffers to Reduce Cyclical Funding Demands on the Market?

November 2020
By Ketan B. Patel

In this blog post, Ketan B. Patel investigates changes in margin at central counterparties (CCPs) during the market stress of 2020:Q1 to show how reactive CCP funding demands were to the increase in market volatility. He examines whether rainy day funding in the form of buffers might be useful in supporting the broader resilience of the clearing ecosystem.

A New Framework for Assessing Climate Change Risk in Financial Markets

November 2020
By Nahiomy Alvarez, Alessandro Cocco, and Ketan B. Patel

While there is growing recognition that climate change poses a new risk for the economy, more research is needed to understand how climate change risk affects global financial markets. We establish a new framework for this research by merging the climate change risk categories of physical risk, transition risk, and liability risk with the risk categories commonly assessed in the financial markets: market risk, credit risk, liquidity risk, and operational risk. We then factor in market structure and market regulation as we seek to assess the overall impact of these variables on systemic risk. Our framework shows that climate change affects each of the risk-management categories commonly assessed in the financial markets as well as the ways that they interact to generate broader systemic risk.

7th Annual Conference on CCP Risk Management

November 2020

Ketan B. Patel will moderate a panel discussion on Resilience and Lessons Learned in Central Clearing in 2020. Senior policymakers, central bankers, market regulators, industry leaders and others are invited to participate in the conference. The CCP Risk Management Conference is by invitation only. To encourage candid discussion among invited participants, the conference is conducted under the Chatham House rule and is not open to the press. This conference has been very well attended in the past.

Diversity in Financial Markets

October 2020

The Chicago Fed and FIA teamed up with a group of expert panelists to explore past and present experiences, as well as the outlook for diversity in financial markets. The panelists explored why diversity is important, how to achieve it, and what metrics could be used to determine progress. During this interactive webinar, panelists also shared their experiences and answer audience questions on impactful changes and how to move your organization and the broader industry forward.

Watch the recording here.

What Are the Financial Systemic Implications of Access and Non-Access to Federal Reserve Deposit Accounts for Central Counterparties?

October 2020
By Maggie Sklar

In this working paper, I examine the interconnections between designated derivatives central counterparties (CCPs) with Federal Reserve deposit accounts and non-designated CCPs and the potential financial stability implications. This working paper notes the interconnections between the non-designated and designated derivatives CCPs through their clearing members and the commercial custodial banks they utilize to hold and transfer collateral. The paper then identifies additional potential contagion risks and financial stability risks, including liquidity risk, market risk, concentration risk, and loss of confidence more broadly. Although there are a number of research articles addressing these topics with respect to designated CCPs or OTC derivatives, this working paper includes the perspective looking at U.S. futures CCPs and non-designated CCPs.

The Future of Innovation in an Inclusive Chicago

October 2020

Chicago is a global hub for innovation in finance, technology, and other sectors. Yet continued innovation is not a given, and the makeup of the city’s population has not been reflected in its most innovative industries. How can Chicago’s history of innovation continue, and how can it include all residents of the city?

Law & Compliance Division Conference

October 2020

Robert Steigerwald participated in a panel discussion of “CCP Risk” at the Futures Industry Association’s Virtual Law & Compliance Conference. The panel discussed CCP risk management issues, including the CCP risk whitepaper, as well as newly finalized amendments to Part 39 regulations.

What Risk Managers from NASDAQ and Options Clearing Corp Learned From the Covid-19 Crisis: Perspectives on Resilience and Challenges During the Pandemic

September 2020

This episode of LaSalle Street welcomes chief risk officers from Options Clearing Corporation and Nasdaq Inc. to discuss what the pandemic is teaching us about risk management and global financial markets.

Clearinghouse Risk, Reference Rates, and Cryptocurrency with Former CFTC Chair J. Christopher Giancarlo

September 2020

The Honorable J. Christopher Giancarlo was on the frontlines of the biggest issues shaping global financial markets as the 13th chairman of the U.S. Commodity Futures Trading Commission (CFTC). Known by some as "CryptoDad," Giancarlo visits LaSalle Street to discuss his reflections a year after leaving the CFTC, key issues he faced during his tenure, and emerging issues shaping the markets today. The conversation includes discussion of clearinghouse risk and the work of the Financial Stability Board, the risks embedded in reference rates, and why regulators should be investing time in the future of digital currency.

The Influence and Limits of Central Bank Backstops

August 2020
By Sam Schulhofer-Wohl

In this post, I explain how central banks’ “backstop” lending facilities can influence financial conditions even when the facilities see relatively little borrowing. The knowledge that credit is available, even if at a relatively high penalty interest rate, can calm markets and encourage confidence in the economy. The availability of a backstop can also influence interest rates on private-sector transactions. However, backstops aim to support normal market functioning—not to make credit cheaper or more plentiful than what a normally functioning market would deliver.

Chicago Fed Hires Ketan B. Patel as Policy Advisor and Head of Financial Markets Risk Analysis

July 2020

Patel will be responsible for analyzing the public policy implications of risks in financial markets and financial market infrastructures. The group’s research on financial market institutions, technology and infrastructure helps inform and foster stable and efficient national monetary, financial and payments systems.

Second Joint Deutsche Bundesbank - European Central Bank - Federal Reserve Bank of Chicago Conference on CCP Risk Management

February 2020
Conference agenda

First Joint Deutsche Bundesbank - European Central Bank - Federal Reserve Bank of Chicago Conference on CCP Risk Management

February 2019
Conference agenda

First Joint Deutsche Bundesbank - European Central Bank - Federal Reserve Bank of Chicago Conference on CCP Risk Management

February 2019
Conference summary

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