United States: CFTC Staff Advisory Sets Challenging Standards For Future Virtual Currency Derivatives

On May 21, the Commodity Futures Trading Commission (CFTC) issued a special Staff Advisory with guidance to regulated trading platforms and clearing organizations that propose to list and trade derivatives contracts on virtual currencies.1 The Staff Advisory follows the somewhat controversial listing of Bitcoin futures contracts on two CFTC-regulated exchanges earlier this year, and focuses on the potential for market manipulation. It was issued only days before reports of investigations by the Justice Department and the CFTC into potential manipulation of the prices for Bitcoin and Ether.2

The Staff Advisory is likely to make it more difficult to list and trade new virtual currency derivatives, resulting in fewer trading options for hedgers and speculators.  It also calls for derivatives exchanges to more closely coordinate surveillance efforts with spot market trading platforms for virtual currencies. As an indirect result, spot trading platforms and their users can expect greater scrutiny from CFTC-regulated entities and from federal regulators.

Summary of the Staff Advisory

Staff Advisory No. 18-14 was issued jointly by the CFTC's Division of Market Oversight and Division of Clearing and Risk, the two divisions with chief responsibility for oversight of trading, trade processing, clearing and exchanges. The Staff Advisory notes that "[v]irtual currencies are unlike any commodity that the CFTC has dealt with in the past," and acknowledges that there are substantial difficulties in ascertaining the relationship between spot market prices for virtual currencies and traditional forces of supply and demand. In this context, the Staff Advisory describes expectations for new derivative products in the following areas: (A) market surveillance; (B) large trader reporting; (C) coordination with CFTC staff; (D) outreach to stakeholders; and (E) risk management for derivatives clearing organizations (DCOs).

A. Market Surveillance

Under the Commodity Exchange Act (CEA), derivatives exchanges must ensure that listed contracts are not readily susceptible to manipulation. Exchanges must also be able to detect and prevent manipulation, price distortion, and disruptions of the delivery or cash-settlement process.3 For these purposes, exchanges must be able to require their traders to provide information about their activities in the underlying spot markets.4 However, the Staff Advisory indicates that in order for an exchange to detect and prevent abuses with respect to virtual currency derivatives, it should also have information sharing arrangements with any reference spot market(s). Such arrangements should provide the listing exchange with the right and ability to access trade data on the relevant spot market(s), including, but not limited to, the identities of traders, prices, volumes, times, and quotes. The staff further expects that derivatives exchanges will base their contracts on prices generated by spot market trading platforms that follow the pattern of federal know-your-customer (KYC) and other anti-money laundering (AML) regulations. If the reference platform is located outside the United States, that platform should comply with its local jurisdiction's KYC/AML standards, which must be consistent with those developed by the Financial Action Task Force on Money Laundering.

Exchanges are also already required to conduct real-time monitoring of all trading activity on their electronic trading platforms in order to identify disorderly trading and any market or system anomalies. Staff Advisory 18-14 elaborates by explaining that for virtual currency derivatives, an exchange should continuously monitor data feeds from the underlying spot market(s) in order to identify events or transactions that might affect trading on the exchange. In such cases, the derivatives exchange should engage in appropriate follow-up, including by obtaining trader-level data from the spot market trading platform. CFTC staff expects that derivatives exchanges will conduct a heightened level of monitoring of the spot markets for virtual currency markets.

B. Large Trader Reporting

Under the CFTC's Large Trader Reporting System, clearing firms, futures commission merchants (FCMs), and foreign brokers (reporting firms) file daily reports that show futures and option positions of traders at or above specific reporting levels.5 Exchanges may set these reporting levels for particular contracts at lower levels than those specified in CFTC rules. In order to assist in the identification of traders who may be involved in manipulation, the Staff Advisory recommends that exchanges set the large trader reporting threshold for any virtual currency derivatives at five Bitcoin (or the equivalent in other virtual currencies).  The staff recognizes that such low thresholds for reporting "will cover 70-90 percent of the total open interest in these contracts."6 Furthermore, the Staff Advisory notes that derivatives traders subject to large trader reporting may also be subject to reporting as to their spot market activities.

C. Coordination with CFTC Surveillance Staff

CFTC Staff expects derivatives exchanges to regularly engage with them on issues related to the surveillance of virtual currency derivatives contracts, and to provide surveillance information upon request. In addition, in order to assist the CFTC's own independent surveillance, the exchange must stand ready to provide any requested data related to the settlement process for spot market trades referenced by the derivative contract. 

D. Outreach to Members and Market Participants

The Staff Advisory notes that certain participants in an exchange or DCO may not plan on trading derivatives on virtual currency but may nonetheless have insights or experience that would be useful in creating and listing a new product. The Advisory states that the process for listing new contracts should include consultation with such participants. As an example, the Staff Advisory notes that clearing members and FCMs, including those who do not plan to offer services related to the new contract, can provide valuable insight into DCO risk management. In its filings with the CFTC, an exchange should discuss opposing views on the listing and explain how any issues raised were addressed.

E. Risk Management by DCOs

For virtual currency derivative contracts that are subject to central clearing, CFTC staff will request and evaluate the relevant DCO's proposed initial margin requirements. Because the spot markets for virtual currencies are notoriously volatile, Advisory 18-14 explains that the Staff will assess whether the proposed margin requirements will be commensurate with the risks involved and that margin requirements for these products are expected to exceed those based on less volatile commodities. The Staff will reject margin standards that it believes are not sufficient to adequately cover potential exposures to clearing members. In addition, the Advisory states that CFTC staff will assess the DCO's adherence to its own product eligibility standards, including those relating to "the availability of reliable prices for the contract, the ability of the DCO to measure risk for purposes of setting margin requirements, and the operational capacity of the DCO and its clearing members to address any unusual product risk characteristics."7

Implications of the Advisory

Two futures contracts on Bitcoin were previously listed on CFTC-registered exchanges pursuant to certification processes that provide for limited CFTC review powers. Staff Advisory No. 18-14 effectively raises the bar for future listings of derivatives on virtual currencies. The Staff Advisory looks to the overall compliance standards for exchanges and DCOs in order to indirectly establish broader authority to review new listings for derivatives on virtual currencies. It also identifies surveillance and enforcement responsibilities that may be challenging to fulfill, and places the onus for compliance squarely on listing exchanges.

The enhanced expectations of the Staff are likely to make exchanges more cautious in listing new derivatives contracts on virtual currencies. Exchanges may find it difficult to have confidence in their abilities to surveil the underlying spot markets for virtual currencies, especially given recent news reports relating to investigations of manipulation. The Staff Advisory may also require derivatives exchanges and spot market trading platforms to examine their current relationships, and require enhanced information gathering from their participants.

Staff Advisory 18-14 therefore makes it more difficult for trading platforms to list and trade new derivatives on virtual currencies. In addition, its characterization of surveillance and other obligations may have an even broader impact that extends beyond derivatives exchanges, and into the underlying spot markets.

Footnotes

1 Advisory With Respect to Virtual Currency Derivative Product Listings, CFTC Staff Advisory No. 18-14 (May 21, 2018) (available here).

2 Bloomberg, U.S. Launches Criminal Probe into Bitcoin Price Manipulation (May 24, 2018).

3 7 U.S.C. 7(d)(3),(4); 7b-3(f)(3),(4).

4 17 CFR §38.253(b); 17 CFR §37.404.

5 See  17 CFR Part 15.

6 Staff Advisory No. 18-14 at 5, n. 17.

7 Staff Advisory No. 18-14 at 6-7, n. 22.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
 
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions