OVERVIEW
For questions on the note below, please contact Scott Parsons, Kevin Batteh, Edmund Perry or Ruth Lunsford at (202) 547-3035.
On October 16, the Commodity Futures Trading Commission’s (CFTC) Division of Clearing and Risk (DCR) held a public roundtable to discuss various new and emerging issues for clearing in the derivatives industry. The roundtable was broken into four different sections, each highlighting a different policy issue: Digital Assets – Their Custody, Delivery, and Use as Margin; 24/7 Trading; Direct Clearing and Margin; and Conflicts of Interest, Affiliations, and Vertical Integration.
PANELS SUMMARY
The first panel featured discussions on which institutions are most appropriate to safeguard customer digital assets and the various requirements the CFTC should consider for their custody.
The second panel featured discussions of the potential risks and opportunities associated with 24/7 trading markets and what guardrails should be put in place if such trading were to be allowed. The discussion covered both the demand for uninterrupted trading as well as the pressure that such markets could place on commercial end-user market participants in terms of capital allocation.
The third panel covered the potential risks and benefits associated with non-intermediated market structures, the potential to allow margined trading in such market structures, and the regulatory requirements necessary to ensure adequate customer protections in non-intermediated markets.
The final panel featured discussions of the conflicts of interest associated with vertical integration or affiliations between market participants that serve different functions within derivatives markets. The discussion covered various guardrails that the CFTC should put in place to ensure that firms with such affiliations or vertically integrated firms protect against conflicts of interest that might harm investors.
Participants in the roundtable discussion were:
- Jan Bart de Boer, Chief Commercial Officer, Abn Amro
- Joseph Guinan, Chairman and Chief Executive Officer, Advantage Futures
- Stephen Berger, Global Head of Government and Regulatory Policy, Citadel
- Sean Downey, Clearing Chief Compliance Officer, Enterprise Risk Officer & Head of Policy, CME Group
- Graham Harper, Head of Public Policy and Market Structure, DRW
- Allison Lurton, General Counsel and Chief Legal Officer, FIA
- Matthew Haraburda, President, XR Trading, on behalf of FIA PTG
- Terrence Dempsey, Vice President of Products, Fidelity Digital Asset Services
- David Downey, CEO, ForecastEx
- Alicia Crighton, Global Co-Head of Futures and Head of OTC and Prime Clearing Businesses, Goldman Sachs
- Kevin McClear, President, ICE Clear U.S.
- Ann Battle, Senior Counsel, ISDA
- Helen Gordon, Managing Director, Global Derivatives Clearing, JP Morgan
- Dave Olsen, President and Chief Investment Officer, Jump Trading Group
- Reginald Griffith, Global Head of Regulatory Compliance, Louis Dreyfus Company
- Zach Dexter, CEO, MIAX
- Matthew A. Daigler, Vice President, Managed Funds Association
- Carol Wooding, General Counsel, NFA
- Demetri Karousos, President, Nodal Clear
- Kaitlin Asrow, Executive Deputy Superintendent, New York Department of Financial Services
- Tyson Slocum, Director, Public Citizen Energy Program
- JB Mackenzie, Vice President & General Manager, Futures & International, Robinhood
- William Thum, Managing Director and Associate General Counsel, SIFMA
- Andrew Smith, Senior Vice President, Virtu Financial
- Matt Lisle, Futures Chief Compliance Officer, Wedbush
OPENING REMARKS
Chairman Rostin Behnam
Addressing the complex issues at hand requires acknowledging the innovative structures and ideas being introduced through emerging technologies. While there may be growing pains along the way, the disruptions we are experiencing ultimately aim to benefit the market. Engagement with industry stakeholders is essential for navigating these changes. Our shared goal is to achieve stronger and more transparent markets that reflect the best interests of all participants.
Commissioner Summer Mersinger
Since 2009, the clearing of derivatives transactions has been recognized as a critical measure in systemic risk prevention. To further this objective, it is vital that we maintain consistent engagement with market participants to address emerging challenges. We must comprehensively assess models that encourage responsible innovation and ensure fair competition, ultimately contributing to a more stable financial environment. By focusing on these areas, we can mitigate risks and enhance market integrity for all stakeholders involved.
Commissioner Caroline Pham
Public engagement and input have never been more crucial as we navigate this transformative era in the markets. A renaissance driven by new technology is enabling direct access and continuous trading, leading to more accessible opportunities for participants. It is essential to develop a robust administrative record that captures these dynamics while emphasizing the importance of vibrant and resilient markets. Protecting all participants remains a top priority as we adapt to these advancements and strive for an inclusive financial landscape.
PANEL I: DIGITAL ASSETS – THEIR CUSTODY, DELIVERY, & USE AS MARGIN
Overview
This panel discussion focused on determining appropriate institutions to custody digital assets and the requirements that the CFTC should impose on those institutions. Participants largely agreed that depositories named in CFTC regulation 120B are not appropriate for holding digital assets without additional requirements. This led to a discussion on the trust company designation created by the New York Department of Financial Service’s BitLicense structure, which was seen as a potential model for regulating digital asset custody at a federal level. The conversation also explored the potential for FCMs to custody digital assets, with concerns raised about regulatory oversight and the legal classification of these assets.
Participants debated whether the CFTC should take a more prescriptive approach by setting specific qualifications and requirements for entities handling digital assets or allow the market to present various options through a principles-based approach to regulation. The conversation ultimately emphasized the importance of assessing the characteristics of custodians, rather than just their registration designation, particularly focusing on the sufficiency of their robust cybersecurity measures, customer asset segregation regimes, and the type and extent of their disclosures.
Discussion
Stephen Berger, Citadel: It is important to consider the broader context when discussing the use of digital assets as margin, and the CFTC should extend the analysis to include the tokenization of traditional assets, rather than focusing solely on cryptocurrencies. This approach could provide a more comprehensive understanding of how digital assets fit into the existing financial regulatory framework.
Sean Downey, CME: The CFTC should consider whether it wants to maintain a principles-based approach or take on the work of determining specific qualifications for entities handling digital assets There are already some appropriate entities currently outlined in existing registration categories, so it might not be appropriate for the CFTC to provide highly prescriptive details. CFTC should consider the treatment of money center countries as an example of a way to establish high-level qualifications without being overly prescriptive.
Graham Harper, DRW: At this time, companies make their own determination on a case-by-case basis on how they want certain assets to be custodied.
Allison Lurton, FIA: The CFTC should pursue a balanced approach to regulation; principles-based regulation and specific requirements are not mutually exclusive. Money center countries represent a precedent for having some specific definitions within a broader regulatory framework. CFTC should also consider borrowing specific elements from existing regulatory structures, such as New York’s BitLicense, while maintaining flexibility for DCOs to build their businesses in a way that serves their needs.
Demetri Karousos, Nodal Clear LLC: Cybersecurity controls are vital in digital asset custody, especially given the finality of transactions and the potential vulnerabilities in hardware and software systems. Digital assets require a highly specialized approach to custody.
Dave Olsen, Jump Trading Group: Entity type is not the appropriate starting point for determining who should be allowed to hold digital assets, but CFTC should provide clarity on this issue to avoid the uncertainty that has plagued the digital assets industry. Most types of collateral could potentially be tokenized and become digital assets in the near future, so the CFTC should be forward-looking as it examines these issues. DCOs should have primary responsibility in determining appropriate collateral, with proper risk management and haircuts applied.
Carol Wooding, NFA: There is a need for specific qualifications and prescriptive regulations to be created for digital asset custodians. It is important for the CFTC to engage with experts across different industries because regulations cannot be developed in isolation. CFTC should engage in a collaborative approach, involving industry experts and other regulators such as the New York Department of Financial Services, to create effective regulations.
PANEL II: 24/7 TRADING
Overview
The discussion focused on the potential for 24/7 trading in the futures market, with a particular emphasis on risk management considerations. While several participants highlighted the demand for the availability of 24/7 markets, there was widespread agreement that any such move must be gradual and carefully planned, with a strong focus on ensuring adequate infrastructure, risk management procedures, and liquidity.
Several concerns were raised, particularly that prefunding requirements for 24/7 trading would increase market risk for commercial end-users and negatively impact efficient capital allocation. There were also discussions on the need for 24/7 risk management capabilities for clearing houses and FCMs to accommodate such trading. Some participants suggested exploring alternative approaches to prefunding, such as the use of letters of credit or increased residual interest, as well as the possibility of expanding the use of regulated stable coins as collateral.
Discussion
Stephen Berger, Citadel: There is not evidence of a universal trend towards 24/7 trading, and some markets have considered reducing trading hours to concentrate liquidity. It is important to address risk management at the clearing level for 24/7 trading. The CFTC should also consider how to handle defaults and liquidations, as well as ensuring that our regulations are consistent with global frameworks.
Sean Downey, CME: The CFTC would be better served by promoting risk management best practices by asset class rather than creating strict regulations. The existing approach to risk management has proven effective across various market conditions, and it should be adapted if 24/7 trading is pursued by the CFTC.
Allison Lurton, FIA: FCMs already have challenges surrounding holiday processing, and there are already concerns with weekend risk being for FCMs and DCOs. The entire regulatory structure is designed to manage risk over extended periods, and current regulations are not yet ready for 24/7 trading. Risk is currently being managed based on regulatory obligations.
Dave Olsen, Jump Trading Group: Markets will be trading 24/7 in the near future, as already seen in Middle Eastern markets and Sunday sessions in India. The CFTC should consider a pilot market to test 24/7 trading of one contract complex with certain protections. It is difficult to trade in thin markets, but this could allow commercial end-users to hedge their risks over the weekend.
Reginald Griffith, Louis Dreyfus Company: The CFTC should not rush into 24/7 trading. These could assign more risk to commercial end-users, particularly in a prefunding model. This would lead to commercial groups having to resort to inefficient capital allocation to ensure that we are not blown out of hedges outside of normal trading hours.
PANEL III: DIRECT CLEARING & MARGINS
Overview
The discussion centered around the opportunities and risks of disintermediated market structures and the role of FCMs in the clearing process. Participants explored the implications of bypassing the role of FCMs. Concerns were raised regarding customer protection, risk management, and the potential for systemic risk in such a model.
While some argued that a direct clearing model could foster innovation and efficiency, particularly for new market entrants, others emphasized the crucial role FCMs play in ensuring market integrity and providing a layer of risk management, expertise, and customer protection.
Discussion
Sean Downey, CME: There are many challenges in replicating all the protections that exist in today’s model on multiple levels when considering disintermediated clearing. It would be difficult to recreate current safeguards in a model without traditional intermediaries.
Graham Harper, DRW: Dual registration for DCOs as FCMs is not absolutely necessary in a disintermediated market.
Allison Lurton, FIA: Operational errors are often caught when functions are separated, and DCOs should register as FCMs if they want to take on those responsibilities. There are always concerns when risk is concentrated in a single entity discharging multiple duties.
Dave Olsen, Jump Trading Group: If a participant is sophisticated enough to meet the standards for direct exchange membership and direct clearing membership, additional registration of the DCO as an FCM might not be necessary. The potential to solve challenges lies in the ability to ringfence and regulate. DCOs are trying to promulgate new markets and solve entry problems, rather than being motivated by profit opportunities or cost reduction through disintermediation.
Reginald Griffith, Louis Dreyfus Company: Direct clearing works well for large, sophisticated firms, and the same protections are in place, but this is not a model that works for the majority of the market. Many protections are already in place for direct clearing members through thorough audits and SRO oversight.
Carol Wooding, NFA: Even if FCM customer protections are applied to DCO retail clients, there is no SRO overseeing that process. Any DCO serving the function of an FCM should be an NFA member, especially since most disintermediated markets are retail facing and must have sufficient customer protections.
PANEL IV: CONFLICTS OF INTEREST, AFFILIATIONS, & VERTICAL INTEGRATION
Overview
The conversation focused on the potential conflicts of interest that arise when market participants begin assuming multiple roles either through affiliations or through vertical integration, particularly as it pertains to affiliated liquidity providers or SRO oversight. A key concern was that such affiliations could create opportunities for the affiliated entities to receive preferential treatment or to use their position to gain an unfair advantage over other market participants.
Several participants pointed to specific examples of potential conflicts, such as when a clearinghouse has an affiliated FCM that goes under or when an exchange acts as the SRO for its own affiliated clearinghouse. Panelists generally agreed that while some affiliations may be permissible with appropriate guardrails, the CFTC should consider prohibiting certain combinations, such as when a DCM is also registered as an FCM and has the role of SRO oversight.
Discussion
Sean Downey, CME: Clearinghouses should be authorized to have affiliated clearing providers with guardrails.
Graham Harper, DRW: Clearinghouses should be permitted to have affiliated FCMs with guardrails.
Allison Lurton, FIA: There should be a rulemaking that prohibits a DCO from owning an FCM and operating as its DSRO. We have concerns that the current structure provides effective incentives and guardrails to prevent conflicts of interest that could negatively impact investors.
Dave Olsen, Jump Trading Group: There are already plenty of examples of conflicts of interests with banks that also have trading arms, but appropriate guardrails and data barriers can allow these structures to function. That said, it is not in anyone’s interest to have even the appearance of conflicts.
Reginald Griffith, Louis Dreyfus Company: These decisions should be made on a case-by-case basis without blanket restrictions.
Carol Wooding, National Futures Association: The CFTC should create a rule that prohibits a DCM with an affiliated FCM from acting as the DSRO.
Other participants discussed topics such as the need for clear definitions of affiliation, the importance of disclosure, the potential for conflicts among affiliates, and the experiences with different regulatory approaches in Europe.