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CFTC Market Risk Advisory Committee

March 8, 2023

Scott O’Malia, ISDA Chief Executive

Counterparty Risk & Liquidity Risk

Good morning, and thank you for inviting me to address this meeting of the Market Risk 

Advisory Committee. I’m pleased to introduce the next section of our agenda, focusing on 

climate risk, market structure and benchmark reform. 

It’s almost three years to the day since the World Health Organization declared COVID-19 to 

be a global pandemic. The rapid escalation of the pandemic in March 2020 triggered the 

biggest shock to global markets since the 2008 financial crisis. Within weeks, asset prices 

plummeted around the world, liquid assets were sold off and risk appetite disintegrated. 

Illiquidity in US Treasury markets was a particular cause for concern.

As we now know, the liquidity shortfall in early 2020 was not an isolated episode. Since the 

pandemic struck, a similar pattern has been repeated in other markets, with an initial shock 

leading to market volatility and liquidity issues. It happened in early 2022, after the Russian 

invasion of Ukraine drove volatility in commodity markets. And again, in September 2022,

when UK gilt yields rose sharply, leading the Bank of England to intervene to calm the 

market.

Now in the early days of this committee, its main focus was on addressing counterparty credit 

risk through clearing, capital and margin rules. The successful implementation of those rules 

has made the system safer and more robust, but it’s clear that markets are now more

susceptible to liquidity risk. Regulators and market participants must work together to

identify and address the drivers of recent stress events so the market can better withstand 

future shocks.

I commend the MRAC for highlighting a number of critical issues as part of today’s agenda. 

I’ll briefly touch on several topics on today’s agenda and how they might be vulnerable to 

counterparty or liquidity shocks. 

I’ll start with digital assets.

Digital Assets

We’ve just heard about the importance of an appropriate regulatory framework for this 

rapidly developing asset class. As the committee continues to study the market and consider

this important issue, I do hope you will look carefully at counterparty risk exposure, and what 

happens when a failure occurs.
2 

Following the collapse of multiple crypto entities last year, it is critical that the legal 

fundamentals regarding bankruptcy and custody are fully considered. We need to ensure 

appropriate and clearly defined custodial and bankruptcy rules are in place, and that all 

participants are aware of their rights and the expected outcomes in a default scenario. 

At ISDA, we have developed valuable resources to address these issues. In January, we 

published a whitepaper on navigating bankruptcy in digital asset markets, with a focus on 

close-out netting and collateral1

. And we will shortly publish a second paper that explores

customer assets held with intermediaries, and how those holdings may be treated in an 

insolvency. In both cases, we can learn from traditional finance to ensure we protect the 

rights of customers in the digital assets market. I encourage the MRAC to consider these 

issues as lessons continue to be learned from recent turmoil in this market. 

Climate Risk

Turning to climate risk, which will be the topic of the next session, further work is required to 

build liquidity and manage counterparty risk in climate markets. We need to move quickly to 

create clarity around the legal framework, establish global product definitions, set high 

standards and develop consistent climate scenario data. Without these vital ingredients, we 

risk fractured, regional markets with insufficient liquidity. This will undermine the key 

objective of driving the trillions of dollars of investment in infrastructure that is needed to 

transition to a sustainable economy. 

At ISDA, we have been working to develop standard definitions and templates that can be 

adapted to ensure climate products are consistently described and documented around the 

world. We published new definitions for verified carbon credits at the end of last year2, and 

we are developing standardized terms and clauses for sustainability-linked derivatives3

. I am 

also hopeful that the Integrity Council for the Voluntary Carbon Markets will be successful in 

setting more selective global standards for carbon credits4. Failure to establish higher

standards and best practices could lead to greenwashing, which will damage confidence and 

stifle liquidity in these markets. 

Now it was the MRAC’s climate subcommittee that published a landmark report in 2020 on 

managing climate risk in the US financial system5. The work to define appropriate risk 

management practices for different climate scenarios is complex and requires extensive 

collaboration between policymakers and market participants. At ISDA, we carried out a 

survey on climate risk scenario analysis for the trading book and we published our findings 

last year6

. We’re now developing further technical guidance that we aim to publish later this 

year. I hope the committee will continue to engage with the market on climate risk 

management as we work through this important topic. 

 

1 https://www.isda.org/a/mIxgE/Navigating-Bankruptcy-in-Digital-Asset-Markets-Netting-and-CollateralEnforceability.pdf

2 https://www.isda.org/2022/12/13/isda-launches-standard-definitions-for-the-voluntary-carbon-market/ 3 https://www.isda.org/2022/11/21/the-way-forward-for-sustainability-linked-derivatives/ 4 https://icvcm.org/the-core-carbon-principles/ 5 https://www.cftc.gov/sites/default/files/2020-09/9-9-

20%20Report%20of%20the%20Subcommittee%20on%20Climate-Related%20Market%20Risk%20-

%20Managing%20Climate%20Risk%20in%20the%20U.S.%20Financial%20System%20for%20posting.pdf

6 https://www.isda.org/a/e55gE/Climate-Risk-Scenario-Analysis-for-the-Trading-Book.pdf
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Block Rules

Turning to the market structure component of today’s agenda, I want to reiterate ISDA’s 

commitment to the regulatory reforms that have improved transparency in the derivatives 

market. The implementation of these rules has made the financial system and our markets 

safer and more resilient. 

It is within this context that I express concerns about changes to the CFTC’s block rules that 

are due to take effect in early December. Based on data from 2020, we estimate these changes 

would raise the threshold for block trades by as much as 100% or, in some cases, 200% from

their 2013 levels. Under the revised thresholds, made-available-to-trade swaps that are 

currently traded bilaterally as blocks will have to be executed on SEFs, with an RFQ going 

out to three parties. Critically, the uncapped notional amounts of these trades will have to be 

publicly disseminated in real time. 

These increased thresholds would have a big impact on market liquidity, exposing dealers to 

‘winner’s curse’, whereby others will know they are looking to hedge in large size. Liquidity 

providers will need to account for this, leading to a widening of bid/offer spreads, increased 

transaction costs and delays in executing hedges.

The key to determining appropriate block sizes is the level of liquidity and risk sensitivity of 

a particular asset class. These measures naturally evolve over time and can change in 

different market conditions. We would urge the CFTC to consult further on how the revised

block thresholds could impact liquidity before they come into force.

Treasury Markets

Finally, I’ll touch on the US Treasury market, the beating heart that keeps liquidity flowing 

through the global financial system. A number of ideas have been discussed to enhance 

liquidity and resilience in this market. Inefficiencies in the US Treasury market could 

adversely affect collateral for derivatives. ISDA members would like to see an outcome that 

increases liquidity in this important market. 

I’ll highlight two particular ideas that have been discussed. Firstly, changes to the 

supplementary leverage ratio and G-SIB surcharge would allow regulated banks to transact in 

the US Treasury market in a more balance sheet efficient and cost-effective manner. Changes 

to these requirements are, of course, a matter for prudential regulators, so I won’t go into 

further detail here.

The second is the SEC’s proposed rules that would require clearing of certain US Treasury 

securities transactions.

Prior to the SEC’s proposal, ISDA carried out a survey on Treasury clearing to help inform 

the discussion. This highlighted a wide variety of views on whether increased clearing of US 

Treasuries and repos would materially improve the resilience and efficiency of the market. 

Most respondents were broadly supportive of clearing, but there was little support for a 

clearing mandate, with suggestions this could lead participants to reduce their activity or 

withdraw from the market.
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The SEC has also proposed that clearing agencies offering clearing of US Treasuries should 

take steps to facilitate access to client clearing. We support these client-based provisions, but

it is important that clearing agencies consult with the market before making any changes to 

client clearing models. This will allow market participants to fully understand and prepare to 

manage the risks, costs and benefits of clearing under those models.

LIBOR Transition

Before wrapping up, I’ll bring to the committee’s attention that the end of US dollar LIBOR 

is fast approaching – the last five settings will cease publication, or potentially become nonrepresentative, on June 30.

Great progress has been made in the transition to alternative reference rates, but as we enter 

the final phase of this multi-year process, we mustn’t lose momentum. Firms should continue 

to proactively move away from LIBOR and use the tools that are available for legacy 

transactions. For non-cleared derivatives, the 2020 ISDA IBOR Fallbacks Protocol remains 

open for adherence. Voluntary transition prior to the deadline is still the best-case scenario,

but derivatives and other contracts that continue to reference US dollar LIBOR must at least 

have fallbacks, like those in the protocol, to provide clarity and certainty.

It’s an honor to provide input on the important and wide-ranging topics on the MRAC’s 

agenda. As that agenda continues to evolve, I encourage you to keep in mind the need to 

address both counterparty risk and liquidity risk. 

Thank you.