CFTC Warns on Bitcoin Futures as Exchanges Ready Contracts

The US Commodity Futures Trading Commission (CFTC) made the unusually guarded statement as the Chicago Mercantile Exchange Group (CME) announced that it had self-certified its futures contract for trading, starting December 18. It added that it had not given its approval to the instrument yet.

The CME contract will have an initial margin rate of 35 percent, the exchange group said, following intensive discussions with CFTC staff over the past several months. It will be a fully cash-settled contract, traded on Globex and cleared through ClearPort, using the CME CF Reference Rate for pricing.

However, despite its limited authority, the CFTC is planning to provide enhanced oversight on nearly all aspects of the contract’s lifecycle, including variation margin payments, monitoring the size of positions and how they change, as well as stress-testing positions.

“If the Commission determines that the margin the [Designated Clearing Organizations] hold against bitcoin futures positions is inadequate, it can take measures to require that the margin held at the DCOs be increased, including requiring that they use a longer margin period of risk to generate margin requirements,” the CFTC said in a statement.

The CFTC’s position that it has limited authority over the markets is somewhat curious, though, given that chairman J Christopher Giancarlo has previously stated that current powers available to the CFTC are sufficient for the task of overseeing areas it has responsibility for.

Speaking to WatersTechnology’s sister magazine Risk.net in November, Giancarlo said: “In the US, our statutory authority over commodities and the Securities Exchange Commission’s (SEC) authority over offerings that provide financing for companies—the two market regulators—have fairly broad jurisdiction in this area, so we’re not calling for any legislative changes. We’ve got what we need to [handle] the challenges facing our jurisdiction.”

In the CFTC’s release, the regulator said that it had also been working with Cboe Global Markets, which was the first exchange group to announce its intentions to launch bitcoin futures in August. The CME announced its own contracts in September, but Cboe has not yet said when trading will commence.

WatersTechnology reported on November 30 that Nasdaq will also launch its own bitcoin futures in the second or third quarter of 2018.

Systemic Concerns

There was a mixed reaction to the news from market participants. One senior executive at an asset management firm that deals with cryptocurrencies says that “the CFTC is responsible for regulating the product, not the cash markets, but that does seem to be a bit of a thin way to hold your hands up and say that you’re not in charge of it.”

“Bitcoin is a speculative commodity at present, and the trading is largely based around getting in on the ride up,” the source says. “Derivatives are an entirely different beast, and I can’t see how they offer a level of economic value equivalent to the potential risk they represent. Even if the CFTC warns in one breath that they’re unregulated and in the next says everything’s fine.”

Others were more forceful, arguing that the introduction of such products could have severe systemic implications if the risks aren’t managed correctly.

“I am stunned by the irresponsible actions taken by the exchanges, run by people who I have a profound respect for—or did—regarding launching these cryptocurrency derivatives and clearing them inside of the AA+ clearinghouses,” says a US-based exchange executive, who asked not to be named. “That the CFTC and SEC wash their hands by saying they don’t have the statutory authority to regulate is an abdication of their responsibilities.”

The problem with bitcoin futures—and their attraction, to some—is that the underlying asset has proved to be extraordinarily volatile. While it has posted tremendous gains in 2017, rising to over $11,000 per coin earlier this week, it has also shown a tendency towards wild swings—shortly after hitting that high-water mark, the currency lost 20 percent of its value shortly thereafter. Such volatility may be suitable for spot currency transactions, but for derivatives, in a market where pronounced losses can act as a force multiplier in risking systemic stability, the picture is quite different.

“The problem is how do the clearing houses contain the risk to the clearing firms that are part of the waterfall pool for the other derivatives,” the exchange source continues. “If the clearing firms crumble, so does the credit rating, which will create enormous chaos.”

Others agree. Thomas Peterffy, CEO of Interactive Brokers, has been an outspoken critic of cryptocurrencies in the past, stating that they should be kept away from the “real economy.” He tells WatersTechnology that a failure of a futures broker dealing with bitcoin products could have significant impacts on investors, who may become exposed to bitcoin indirectly via the actions of their brokers’ other customers. In a clearinghouse environment, where risk is mutualized into default funds and collateral pools, the effects could be even more pronounced, a potential domino effect that he says “scares the hell out of me.”

“The clearinghouse is exposed to the health of the broker,” he says. “So even if you choose a broker who does not take any customers with bitcoins, you are still exposed, because if the brokers who do have bitcoin customers fail, that could destabilize the clearinghouse and could cause the broker who does not have any bitcoins to become unable to serve its customers.”

In a statement, CME chairman and CEO Terry Duffy said that the exchange recognizes that bitcoin is a “new, uncharted market that will continue to evolve, requiring continued collaboration with the [CFTC] and our clients going forward.”

“At launch, our new Bitcoin futures contract will be subject to a variety of risk management tools, including an initial margin of 35 percent, position and intraday price limits, and a number of other risk and credit controls that CME Group offers on all of its products,” Duffy continued.