Last week, one of the main global-oil-price benchmarks, the West Texas Intermediate (WTI) exchange-traded future, traded below zero as the contract for May settlement approached expiry on Monday. This meant that sellers of the contract on that final day of trading were being forced into paying buyers to offload their positions, rather than the other way around.

Partly a by-product of the Covid-19 crisis driving oil demand to an all-time low, the drop into negative territory was exacerbated by a flood of new money into exchange-traded funds (ETFs) that track the underlying WTI oil future. Investors were betting that early April oil prices marked the bottom of the market. Both financial and mainstream press have covered the implications extensively – from oil supply and demand, to storage issues and investor impact – with the usual conjecture about financial winners and losers.

In this note, we will look at the practical issues that a negative asset price can have on trading, settlement, risk and accounting systems. Also, we’ll highlight possible actions in preparation for, and to protect against, negative prices, whether in oil or other financial products. Regulators around the world continue to emphasise the importance of learning from similar events in other financial markets. It’s not the first time that the price of a financial instrument has traded below zero, even in the Commodities sector (negative natural gas prices are increasingly common, at least in the US). Negative yields and spreads in financial products from other sectors have been commonplace since the 2008 financial crisis, and it’s imperative that we look beyond the headlines and consider what can be learnt, practically, at least as far as technology systems are concerned.

What’s the Issue?

A bond with a negative yield will still trade (and settle) on a positive asset price. Receiving monies in return for parting with ownership of the asset, still holds true despite the negative yield, which only reflects the annualised return for holding the asset to maturity. But when the asset itself is trading at a negative price, other considerations come into play. Who is paying whom for the exchange of the asset? Am I expecting to have to make a payment to, instead of receiving one from, the buyer, as well as handing over the asset? And, how is that reflected in my systems?

Pricing, Orders, Quotes and Trade Execution – things to consider

• Is my market data feed set up correctly to handle negative asset prices? Fundamentally, if an instrument can be traded on an exchange or venue with a negative price, then the associated market data feeds and components must be checked to ensure they don’t grind to a halt. Or even worse, silently throw away the ticks or force them to zero.
• What about pricing and risk models or systems that process that data – whether to carry out analysis, or derive a price to send out as an order or a quote. What happens if they get a negative value where they’ve never had one before? Is the received or derived value processed and/or displayed correctly, and is there a need for improved error handling or alerting to bring the situation to the attention of a user or support staff member? End User developed apps such as spreadsheets need particular attention.
• How does pre-trade risk-limit-checking work with a negative price, particularly if these are working on a net position basis? A break or mistake here and a lot of money can be lost very quickly.
• How is unauthorised trading monitoring affected? Banks have stepped up their game since the Adoboli incident in 2011, by implementing gross and net delta exposure checks. But with a negative notional amount, doesn’t this open up the possibility of concealing the true delta risk within a trading book?

Post-trade considerations

• Assuming a trade is done, can it be input into the trade capture system?
• What’s the impact on regulatory trade and transaction reporting feeds? A mistake or a delay in either can have regulatory consequences and fines.
• What about margin and risk calculations? Are these calculated correctly at a trade level, or netted accurately when rolled-up to a book or portfolio level?
• Don’t forget the trade affirmation and confirmation systems – the data and docs that contractually bind the two parties – and the associated ISDAs, Credit Support Annexes and lending agreements. Are you legally covered at both master agreement level and for trades executed at a negative price? And, is the legal basis of the trade reflected accurately on the affirmation and confirmations?
• Then there’s the actual exchange of cash/securities. Payments and position-based securities are often netted, will this net accurately? Is the money and asset moving in the expected direction?
• If trading on behalf of a client, what reporting do they expect from you as their counterparty such as confirmations and delegated reporting, and be sure to check if they also have systems issues – they will thank you for going the extra mile.
• Reconciliations and accounting; often coded so far away from the front office that assumptions are baked into the coding and configuration of the feeds and destination systems. But an unexpected outage here – even for a few hours – can lead to a backlog of position or cash breaks, or delays to PnL reporting that could take the relevant business teams days to respond to, especially in these short-staffed Covid-19 times.

You may not have been impacted directly by negative oil prices, but the industry must continue to learn from past issues. The FCA made this clear as far back as 2014, with Tracey McDermott stressing the industry's failure to learn from Libor manipulation when risk-assessing the FX and gold markets. With the senior-manager-certification regime now in place across the industry, not learning from concurrent asset class experiences will doubtless fall on unsympathetic ears.

Rich Evans

Based in London, Rich is Global Solutions lead for Regulation and Compliance at DXC Technology. He joined DXC from Barclays where he was Head of Equities, EMEA, and Chief Operating Officer for Global Equities. Rich has held a number of senior leadership positions in capital markets at Citi and Morgan Stanley focused on quantitative trading and automation, as well as leading regulatory change programs including Mifid 1&2.

He is currently co-chair of Fixtrading.org, and prior chair of the Equities Board of the Association for Financial Markets in Europe (AFME). He was an expert witness in the largest fraud case in UK history (Adoboli), where he assisted the court in understanding the business of financial services.

Matt Hargreaves

Matthew Hargreaves has more than 20 years’ combined expertise and international leadership experience as a CIO and COO in the Financial and Capital Markets industry. His career spans Credit Suisse, Deutsche Bank, Credit Agricole, Daiwa Capital Markets and Lloyds Banking Group. Matt joined DXC Luxoft in March 2020 to lead Capital Markets Solutions, globally.

About DXC

DXC Technology Banking Capital Markets (BCM) enables financial institutions to build their digital future while simultaneously optimising and transforming their legacy operations. We solve front-to-back challenges of investment banking, asset management, wealth management, commercial banking and retail banking clients, through our offering portfolio of advisory services, analytics capabilities, engineering services, hosted and deployed products, cloud services, security services, and ITO. We partner with leading financial technology companies to deliver the best, most proven solutions to optimise technology investments.

We have 45 years’ experience in serving this industry. Our team of 13,000 financial professionals support more than 1,000 institutions in over 70 countries. We process over 80 million payment accounts, service 2.5 million mortgages globally, and work with 60% of financial services banks and corporates in the Fortune Global 500.