Stay on Alert: CFTC Staff Reminds Registered Exchanges and Clearinghouses to Evaluate and Calibrate Their Volatility Control Mechanisms

The Commodity Futures Training Commission’s (“CFTC”) Division of Market Oversight and Division of Clearing and Risk issued an advisory (the “Staff Advisory”) reminding designated contract markets (“DCMs”) and derivatives clearing organizations (“DCOs”) of their regulatory obligations under the Commodity Exchange Act (“CEA”) and CFTC regulations to implement and consistently evaluate the efficacy of their controls designed to address market volatility. These controls—referred to as volatility control mechanisms (“VCMs”) by the Committee on Payments and Market Infrastructure and the International Organization of Securities Commissions—are especially important in today’s environment, where global events such as pandemics, wars, sanctions, political instability, and abrupt policy changes can drive extreme volatility. 

The May 22 Staff Advisory reflects the most recent development in the industry related to VCMs. In September 2023, the Futures Industry Association (“FIA”) published a paper supporting VCMs, noting their effectiveness in preserving market integrity by mitigating disruptions from sudden price swings, erroneous orders, and feedback loops under stress (“FIA Best Practices”). FIA also advocated for a principles-based approach to VCM design to ensure adaptability across asset classes and changing market conditions.

The FIA Best Practices recommended that DCMs implement robust, flexible controls such as circuit breakers, price bands, and pre-trade risk checks that are tailored to their specific markets and trading conditions. For DCOs, the Staff Advisory underscores the potential impact of VCMs on clearing functions, particularly around variation margin and settlement pricing during volatile periods. DCOs must exercise discretion in ensuring settlement prices reflect market reality when normal pricing methods are disrupted, and should transparently communicate such deviations to clearing members and end-users. 

In November 2023, the CFTC’s Global Markets Advisory Committee (“GMAC”), chaired by Acting Chairman Caroline Pham, played a pivotal role in advancing these best practices. Composed of a broad cross-section of market infrastructures, participants, end-users, and regulators, GMAC recommended that the CFTC leverage the FIA Best Practices to deepen its understanding of exchange-level risk controls and as a foundation for engagement with global regulators and international standard setters. 

In line with this recommendation, the Staff Advisory reinforces that DCMs and DCOs are expected to fulfill their existing responsibilities and incorporate best practices to maintain fair, orderly, and resilient markets during times of elevated volatility.

The Staff Advisory is available here. FIA’s Best Practices is available here.