How Will New CTFC Guidance for Exchanges Impact Investors?

Books on a table and a gavel.

On May 21, 2018, the U.S. Commodity Futures Trading Commission issued an advisory on the listing of altcoin derivative products. Following the ruling of U.S. District Judge Jack Weinstein on March 6 that altcoins can be regulated by the CFTC as a commodity, the CFTC has issued a joint staff advisory to CFTC-registered exchanges and clearinghouses.

The advisory aims to create new checks and protections for investors against derivatives brokers and exchanges. The idea is to prevent the marketplace from being flooded with misleading or corrupt contracts and to create a framework for these contracts’ prevention and investigation.

“The CFTC staff is committed to providing regulatory clarity as much as possible,” Commodity Futures Trading Commission Division of Market Oversight Director Amir Zaidi said. “As the virtual currency market continues to evolve, CFTC staff will seek to provide additional guidance to help market participants keep pace with innovation while complying with CFTC regulations.”

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Noting that the advisory is not a compliance checklist nor does it carry the threat of law, the advisory clarifies the CTFC’s expectations and priorities in the future review of derivatives on a designated contract market (DCM), a swap execution facility (SEF), or a derivatives clearing organization (DCO). This advisory can form the framework of new regulations and rules in the altcoin derivatives sphere.

Here’s a look at what this advisory has to say and what it means to altcoin investors.

Enhanced Market Surveillance

The CFTC distinguished altcoins from other commodities in the sense that the buying of altcoins precludes any commercial use of the altcoin. For example, Ripple tokens are important because they are the transfer devices for transnational and peer-to-peer money transitions. Despite this, Ripple has more value as tradeable commodities on the altcoin market, and this value is in no way attached to the utilitarian worth of the altcoin. (This is in opposition to oil, for example, which may have trade value, but that value is related to the value of the energy that measure of oil can deliver.)

The problem is that the risk of abuse is great. The CTFC recognizes that the price given in the various altcoin markets may not reflect supply-and-demand, intrinsic value, or the conditions of any commercial market, and may just be a reflection of daily selling, opening the possibility of market manipulation and extreme price swings.

Thus, DCMs and SEFs must establish an oversight program that ensures that listed contacts are shielded from manipulation and that any manipulation is detected quickly. The DCMs and SEFs must be able to obtain not only trader information regarding activities in the spot market – including, but not limited to, trader identifying information, and trade prices, times, quotes, and volumes – but also must maintain real-time monitoring of all trading activities on all electronic trading platforms. By maintaining consistent watch, the CFTC feels that anomalies and fraudulent actions can be detected in real-time.

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The CTFC also expects close coordination and communication in the listing exchanges, particularly in the monitoring of derivatives contracts fraud. “Staff expects exchanges to regularly discuss with Commission staff a wide range of issues related to the surveillance of virtual currency derivatives contracts, and provide surveillance information as requested by Commission staff,” the guidance letter reads. “Upon request, the exchange must also provide to Commission staff data related to the settlement process referenced by the contract to enable staff to conduct its own independent surveillance.”

Altcoin derivatives merchants and brokers will also be expected to comply with the CFTC’s Large Trader Reporting System, which requires daily reports showing future and options positions for traders trading above specific reporting levels. The exchange can set the reporting level below the commission’s level if desired.

The CFTC suggests that the exchange or broker, before offering a derivative option, reach out and solicit comments and opinions on the listing. The idea is that opposing views from stakeholders can help point out potential problems in the future listing and help shape the contract’s procedures and terms and conditions.

The CFTC will also request information from the DCOs identified for clearing a proposed derivatives contract, including proposed initial margin requirements and rules governing the approval process. The CTFC may request corrections if the information provided suggests that the DCO has not properly covered the risk involved in the contract.

As the CTFC will take an active role in the supervision of altcoin derivatives, failure to comply with the commission’s guidance will result in direct intervention by the commission, including writing to the exchanges and publishing the letters with the public or other regulators, as needed. This letter represents both a hardening of the government’s attitude toward altcoin instruments and an embracing of the inevitability of such devices. While the letter does not represent any rules as of yet, it can be read that the CTFC will follow through with this framework for future regulations, potentially creating a template for other regulators.

“CFTC staff is providing this information, in part, to aid market participants in their efforts to design risk management programs that address the new risks imposed by virtual currency products,” CTFC Division of Clearing and Risk Director Brian Bussey said. “In addition, the guidance is designed to help ensure that market participants follow appropriate governance processes with respect to the launch of these products.”

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