CFTC Stresses Exchange Role in Crypto Derivatives Guidance

While the CFTC staff advisory, issued on May 21, described virtual currencies as “unlike any commodity that the CFTC has dealt with in the past,” it largely shied away from committing the regulator to direct intervention.

Instead, in a series of bullet points, it provided guidance stating that exchanges listing contracts on these commodities should engage in a range of measures, stretching from enhanced surveillance of the spot exchanges where price formation occurs through to what it regards as appropriate levels of member and participant outreach when new contracts are being considered.

On the surveillance point, the CFTC reminded venues and swap execution facilities (SEFs) that they must already be able to obtain information on activities in underlying spot markets. However, the CFTC said that it expects those listing virtual currency contracts to continuously monitor price and volume feeds, particularly around and during settlement periods, and to further engage in enhanced inquiries if suspicious patterns of behavior are detected.

“Commission staff would expect the exchange to engage in appropriate inquiries, which may include obtaining spot market trader-level data. Given the nature of the underlying spot market, staff believes that a heightened level of monitoring, with respect to trading activities on the spot market, is warranted,” the advisory said. It further added that it expected the development of future contracts to be based on products traded by exchanges that follow suitably rigorous regulations on know-your-customer and anti-money laundering activities.

In addition to provisions on working closely with the CFTC surveillance group, and setting a threshold under which firms would be required to report transactions to the agency under the large trader reporting regime—which the CFTC said would be a trade size of five bitcoins or more—it also stressed the importance of working with the market.

The launch of futures on bitcoin late last year by both Cboe Global Markets and the Chicago Mercantile Exchange Group (CME) provoked a level of opprobrium from dealers and their trade bodies, who were concerned that the self-certification process used by the exchanges to list the contracts meant that discussions around prudent risk management and other concerns largely excluded them. Since their launch, the futures have largely shown subdued activity, but have been subject to odd movements on occasion that appear unrelated to settlement dates—on April 25, for instance, Cboe’s average daily volumes were three times the norm, and CME’s were double (see chart).

The concerns culminated in a letter sent by Walt Lukken, CEO of the Futures Industry Association (FIA), to the CFTC on December 7, urging a review of the process. Although the exchanges rebutted the concerns and pointed to the fact that they had worked closely with regulators throughout the process, J Christopher Giancarlo, chairman of the CFTC, subsequently said that he would be instructing agency staff to address the issues raised.

The FIA did not respond to a request for comment on the staff advisory in time for publication, and Cboe Global Markets declined to comment. A spokesperson for the CME said that the exchange operator would “look forward to continuing to work with the CFTC and our customers as the cryptocurrency markets develop.”

The CFTC said that an explanation of substantive opposing views regarding the listing of contracts should be considered for inclusion in any submission or filing with the regulator and that consultations should cover areas beyond the technical factors of a contract.

Finally, on risk management, the CFTC was more proactive, stating that it would actively review the risk procedures detailed for any contract, and that it would require clearing organizations to make adjustments in the event that it considered such arrangements to be inadequate, particularly regarding the level to which initial margin requirements would be set.

“These markets have a very short history of trading, marked by substantial periods of volatility and price swings. This raises questions about whether clearinghouses can adequately assess the inherent risk of virtual currency contracts in setting margin levels for these contracts,” the regulator said.