Tuesday, January 23, 2018

Surging torrent of virtual currencies spurs Chairman Giancarlo to call for expanded CFTC oversight

By Brad Rosen, J.D.

In remarks before an elite group of derivatives and futures lawyers in Naples, Florida, CFTC Chairman J. Christopher Giancarlo again advocated for rigorous, but common sense, oversight of the ever-expanding cryptocurrency markets and their related derivative offshoots. Notably, Giancarlo called for the potential enactment of formalized rules and heightened review requirements in connection with exchanges self-certifying new cryptocurrency-related futures contracts in a speech before the ABA Derivatives and Futures Section conference.

In calling for expanding the scope of CFTC oversight, Giancarlo noted that in the waning months of 2017, virtual currencies, especially Bitcoin, took the world by storm. Bitcoin itself increased in value over 13-fold in 2017, prompting Giancarlo to observe, “In recent years, a number of these technologies have turned from several tributaries into one river, which recently became a surging torrent, a gulf stream.” Giancarlo continued, “[Virtual currencies] are sweeping us rapidly, day-by day, hourly, into a new future. And that torrent is bumping up against some of the established frameworks of futures regulation, including the obligation of futures exchanges to ensure that virtual currency futures are not susceptible to manipulation, and of futures clearinghouses to ensure that such products are adequately risk managed.”

Chairman Giancarlo’s stated approach regarding virtual currencies stands in stark contrast with the SEC, which all but shut the door in connection with approving exchange-traded funds (ETFs) that hold Bitcoin or other cryptocurrencies, as detailed in a recent staff letter. Rather, the Chairman asserted, “Virtual currencies demand the focused attention of this group. We cannot ignore them. This is not the time or place for denial or misunderstanding or personal preference. This is the time for recognition, reflection, and wisdom … a time to set the course for the future … navigating through new waters. Not tomorrow. Today.”

Self-certification of Bitcoin futures contracts and related criticisms. The chairman noted that the CFTC has been subject to an abundance of criticism with respect to its approach in connection with the launch of Bitcoin futures contracts and the role it played in the exchange self-certification process.

The chairman took the opportunity provide some background and context on this score. He explained that the self-certification framework, as provided by Congress and prior commissions, was deliberately designed so that exchanges, in their role as self-regulatory organizations, could design and certify new products, so that the development of new and innovative derivatives products would not be hampered by cautious regulators driven by political concerns. The chairman specifically noted that applicable statutes and rules do not provide for holding public hearings or obtaining public input prior to self-certification, despite protests from various marketplace stakeholders.

CFTC impact on the contract review process. Despite the Commission’s constrained authority to review new products which are the subject of the self- certification process, Giancarlo pointed out that CFTC staff obtained the voluntary cooperation from the exchanges in an unprecedented manner, resulting in the exchanges agreeing to the following review checklist:
  • setting exchange large trader reporting thresholds at five Bitcoins or less;
  • entering into information sharing agreements with spot market platforms to allow access to trade and trader data;
  • engaging in monitoring of price settlement data from cash markets and identifying anomalies and disproportionate moves;
  • agreeing to conduct inquiries when anomalies or disproportionate moves are identified;
  • agreeing to regular communication with CFTC surveillance staff on trade activities, including providing trade settlement and trader data upon request; 
  • agreeing to coordinate product launches to enable the CFTC’s market surveillance branch to monitor minute-by-minute developments; and 
  • setting substantially high initial and maintenance margin for cash-settled instruments. 
Potential changes to the self- certification process. In order to avoid future controversies around the lack of public or stakeholder input, Chairman Giancarlo has asked CFTC staff to add an additional element to its review checklist. In particular, an exchange or SEF introducing a new virtual currency derivative would be required to disclose to the CFTC the steps taken, in their capacity as a self-regulatory organization, to gather and accommodate appropriate input from concerned parties, including trading firms and FCMs.

Lastly, but importantly, Chairman Giancarlo has also asked staff to consider various rule changes which would elevate various elements from the above checklist to legal requirements rather than being deemed voluntary undertakings. Moreover, the chairman has asked the CFTC’s General Counsel to further explore codifying elements of the review checklist and to consider possible regulatory and/or statutory steps which would necessarily result in an expansion of the scope of the Commission’s oversight in the virtual currency realm.