On January 31, 2018, at a meeting of the CFTC's Market Risk Advisory Committee, Commissioner Rostin Benham called the launch of bitcoin futures a "testament to the forward thinking, innovative spirit of the derivatives market."
The agency has been the target of criticism from the Futures Industry Association and others due to concerns that the CFTC's self-certification process used for virtual currency products is insufficiently rigorous. The process does not provide for public input.
Today, Benham explained that the listing of bitcoin futures sparked new interest in the CFTC's role in product listings. The commissioner provided some background on the matter.
"Generally, under the [Commodity Exchange] Act, an exchange may either elect to list a new product for trading under Regulation 40.2 through written certification that the new contract complies with the Act and Commission regulations, or it may request that the Commission grant prior approval for the listing of the new contract under Regulation 40.3.5 If an exchange requests approval under Regulation 40.3, the Commission then must approve the new contract, unless it finds that the contract would violate the Act or Commission regulations."
Behnam highlighted the fact that 10,628 new products have been listed by 15 exchanges since the year 2000, when Congress authorized the agency to establish the self-certification process. Chairman Christopher Giancarlo then mentioned that at a conference earlier this month, a senior European markets regulator "brought up the CFTC's self-certification process and said that it was the reason why almost all new financial products originated out of the United States."
Clearly, self-certification has its merits.
Still, this begs the question, are virtual currency derivatives suitable for self-certification?
On January 19, 2018, at the ABA Derivatives and Futures Section Conference in Naples, Florida, Giancarlo discussed the CFTC's "heightened review" process for virtual currency derivatives, which the CME and CFE voluntarily participated in. The review includes several elements:
"1. Designated contract markets (DCMs) setting exchange large trader reporting thresholds at five Bitcoins or less;
2. DCMs entering direct or indirect information sharing agreements with spot market platforms to allow access to trade and trader data;
3. DCMs agreeing to engage in monitoring of price settlement data from cash markets and identifying anomalies and disproportionate moves;
4. DCMs agreeing to conduct inquiries, including at the trade settlement and trader level when anomalies or disproportionate moves are identified;
5. DCMs agreeing to regular communication with CFTC surveillance staff on trade activities, including providing trade settlement and trader data upon request;
6. DCMs agreeing to coordinate product launches to enable the CFTC's market surveillance branch to monitor minute-by-minute developments; and
7. DCOs [derivatives clearing organizations] setting substantially high initial and maintenance margin for cash-settled instruments."
On Wednesday, the chairman introduced the eighth element. "That is requiring DCMs and Swaps Execution Facilities (SEFs) to disclose to CFTC staff what steps they have taken in their capacity as self-regulatory organizations to gather and accommodate appropriate input from concerned parties, including trading firms and Future Commission Merchants (FCMs)," explained Giancarlo.
"Further, I have asked staff to take a close look at DCO governance around the clearing of new virtual currency products and formulate recommendations for possible further action," he added. "There may well be other improvements to consider."
"For those who want regulators to remove all financial risk from the markets, I have news for you. That cannot and will not happen," he declared. "Every element of the financial system has and always will have risk. Our markets' ability to empower risk takers, provide feedback on value creation vis-à-vis its riskiness, and transfer risk to those most willing and able to bear it are what make them the envy of the world. I would seek to preserve those market functions, not bureaucratize them."
He also noted that "self-certification is where a new contract's regulatory life begins, not where it ends. After a contract's self-certification and its initial listing, the CFTC will then surveil that product's trading and clearing activity on a daily basis, review every new rule issued by exchanges and clearinghouses affecting that product, and regularly perform market-wide and clearinghouse-level stress tests incorporating that product's margin sufficiency."
Ultimately, it appears that the CFTC remains agnostic to the self-certification process itself.
What really matters is that manipulation of virtual currency products is possible, which is a point that the CFTC may need to consider more carefully. If the agency hopes to keep America's listed futures markets as "the envy of the world," then balanced oversight and continued dialogue will be necessary.
The CFTC and SEC will testify before the Senate Banking Committee next Tuesday, February 6, 2018.