Last week, the Market Oversight and Clearing and Risk Divisions of the Commodity Futures Trading Commission (“CFTC” or “Commission”) issued Staff Advisory No. 18-14 regarding virtual currency derivative product listings. The advisory serves as guidance to exchanges and clearinghouses in the context of listing derivative contracts based on virtual currency under Commission Regulations 40.2 (self-certification) or 40.3 (voluntary submission for Commission review and approval) in order to promote effectiveness and efficiency in the emerging area virtual currency derivatives.
Specifically, the advisory clarifies CFTC priorities and expectations for virtual currency derivatives listed on a designated contract market (“DCM”) or swap execution facility (“SEF”) or cleared by a derivatives clearing organization (“DCO”) with regard to enhanced market surveillance, coordination with CFTC staff, large trader reporting, stakeholder outreach, and DCO risk management. The Commission notes that this latest effort at providing regulatory clarity is not a “compliance checklist,” and the extent of its relevance depends on the terms and conditions of each virtual currency contract.
Enhanced Market Surveillance: DCMs and SEFs are responsible for having an oversight program designed to ensure listed contracts are not readily susceptible to manipulation and to detect and prevent manipulation, price distortion, and disruptions of the delivery or cash-settlement process. To increase visibility into underlying spot markets and manage risks related to the trading of listed virtual currency derivatives, the Commission advises having an information sharing arrangement in place with the underlying spot markets that may contribute to the cash-settlement price in order to provide the derivatives exchanges access to a broader range of trade data, including trader identity, prices, volumes, times, and quotes.
The Commission also advises a heightened level of real-time monitoring that involves continuous monitoring of relevant data feeds (particularly around settlement) and making inquiries where appropriate in the event of identified anomalies or disproportionate moves in spot markets.
Coordination with CFTC Staff: The Commission expects exchanges to regularly discuss virtual currency derivatives contracts surveillance issues with CFTC staff and to provide information upon request, including data related to the settlement process referenced by the derivatives contract.
Large Trader Reporting: The Commission may raise or lower reporting levels in specific markets under the Commission’s Large Trader Reporting System. Exchanges can set the reporting level of contracts in a particular commodity at a lower level than specified in CFTC regulations, but the Commission recommends setting the large trader reporting threshold for any virtual currency derivative contract at five bitcoin (or the equivalent) to facilitate surveillance.
Stakeholder Outreach: The Commission expects exchanges to take extra care to engage meaningfully with stakeholders due to the novel and evolving nature of virtual currency contracts and concerns related to price volatility and lack of transparency. The effort should include soliciting comments on a broad array of topics related to the listing that go beyond the terms and conditions and manipulation susceptibility from members as well as other relevant stakeholders that go beyond those interested in trading the contract (e.g., clearing members and futures commission merchants (“FCMs”). When submitting a virtual currency derivative contract listing, an exchange should provide as much information as possible, including explanations of substantive opposing views and how the exchange has addressed them.
DCO Risk Management: CFTC staff will request and review from the identified DCO: (1) proposed initial margin requirements to assess whether they are commensurate with the risks; (2) ability of proposed margin requirements to adequately cover potential future exposures to clearing members based on an appropriate historic time period (and may require adjustments); (3) information related to the governance process for approving the proposed contract(s), including explanation of views of approving clearing members and the response to dissenting reviews; (4) adherence to internal governance procedures for new contract approval; and (5) any other information relevant to the clearing of the proposed contract.
Exchanges and clearinghouses are currently evaluating new crypto products, and these guidelines setting forth the Commission’s expectations with regard to that process will help streamline the new contract listing procedures. It also emphasizes a current priority for the CFTC, which is to obtain more information regarding the crypto spot markets, which they hope to accomplish via the registered platforms. Market participants are looking forward to seeing a wider variety of crypto derivative products, and hopefully this guidance will speed that process.