Friday, February 16, 2018

Rescheduled TAC meeting worth waiting for

By Brad Rosen, J.D.

Commissioner Brian Quintenz led off the first meeting of the CFTC’s Technology Advisory Committee (TAC) in 22 months, noting the rapid evolution of technological developments in the derivative markets even since the committee’s last gathering in 2016. The TAC meeting, which was rescheduled due to the brief government shutdown in January, consisted of comprehensive and engaging discussions exploring five key areas impacting the global markets including digital ledger technology, virtual currencies, artificial intelligence, automatic trading, and cybersecurity.

Chief Innovation Officer Daniel Gorfine, who serves as TAC’s designated federal officer, oversaw the day’s proceedings which included presentations from some of the leading figures in derivatives and technology space. Commissioner Quintenz, the TAC sponsor, was also joined by his fellow commissioners, Chairman J. Christopher Giancarlo and Rostin Behnam. Some of the highlights and insightful observations that came out of the meeting follow.

2018 is the year digital ledger technology is about to get real. Charley Cooper, a managing director with R3, a company that leads a consortium of more than 70 of the world's largest financial institutions in the development of distributed ledger technology, sees commercial deployments of distributed ledger solutions taking hold in 2018. Cooper also implored U.S. regulators and governments to be intimately involved with regulated financial institutions as these markets and technologies continue to evolve.

The view from a regulator. CFTC Division of Market Oversight (DMO) Dan Busca responded favorably to Cooper’s call. He noted that providing the CFTC with a seat at the table will afford the agency the opportunity to provide input and minimize the burden of regulatory requirements. Specifically, Busca noted, “The evolution of DLT could allow regulators to access data automatically and seamlessly every time a trade is posted on a particular blockchain without the need for human intervention or intermediaries.” He added, "It could increase the speed and improve the reliability of data. Commission access could be incorporated into distributed ledgers of reporting parties.”

State regulation of the cryptocurrency ecosystem is inefficient and burdensome. Jerry Brito, a prominent voice in the crypto-regulation space and the executive director of Coin Center, noted the primary role of the states in regulating spot cryptocurrency markets, though their money licensing requirements, and the problems resulting from approach. He observed that firms must seek a license in every state in which they do business in, in which they have customers, and for an internet business that means every state. Brito noted a firm is made no safer to the consumers when it passes its 50th background check than when it passed its first. Brito also noted state by state money transmission licensing has no provision for market supervision or exchanges, which is increasingly of interest to federal policymakers.

Gary DeWaal, special counsel at Katten Muchin Rosenman, amplified these views and further warned of the dangers of regulatory proliferation. He noted that New York state came up with a bit license where six firms are regulated as limited purpose trusts effectively applying the bit license rules in New York state. He also observed the state recently expanded its requirements so as to deal with additional oversight, manipulation and fraud. DeWaal cautioned, “it's not like the bit license replaced the money transmitter requirements. It's both. And it's not like anyone is talking about implementation of this new virtual currency act replacing money transmitters.”

More promising, as noted by Brito, the uniform law commission has developed a uniform virtual currency business regulation act that is now being considered by several states. He concluded, “Unfortunately a state by state reform does not scale.”

Battle lines remain drawn over Regulation AT. Commissioner Behnam stated that he was pleased that the TAC plans to resuscitate at least some of Regulation AT (Reg AT), noting that the Commission issued proposals in both 2015 and 2016 to establish pre-trade risk controls in an effort to mitigate the potential dangers of an unchecked automated trading system. Benham asserted that it is vitally important that the Commission take immediate action on Reg AT before an automated trading system that runs amok causes harm to market participants. On this point, he concluded, “the question of a market event, flash crash or otherwise, is not if, but when.”

While not specifically responding to Commissioner Behnam’s comments, Bryan Durkin, president of the CME Group, set forth a vigorous and impassioned defense of the CME’s active measures and protocols to address risk, volatility and potential disruptions. He noted, “These protocols include global credit controls, price spanning, price order quantities, messaging controls, stop logic functionality, such as circuit breakers, price protection points and kill switches.” Durkin continued, “Our credit controls, which every clearing firm utilizes, includes mechanisms such as order blocking, order cancellations, automated email notifications, and these can be set at various levels and thresholds.”

More to come. During the course of the TAC meeting, the committee members approved the creation of four subcommittees covering Blockchain developments, virtual currency regulation, automated trading technologies, and cybersecurity. Accordingly, it appears that there will be more to come from TAC under the leadership of Commissioner Quintenz and Chief Innovation Officer Gorfine.