Crypto Exchange FTX Files with CFTC to Offer Disintermediated Retail Crypto Derivatives | Practical Law

Crypto Exchange FTX Files with CFTC to Offer Disintermediated Retail Crypto Derivatives | Practical Law

The CFTC is seeking public comment on a request by LedgerX, LLC d/b/a FTX US Derivatives (FTX), a cryptocurrency exchange registered with the CFTC as a derivatives clearing organization (DCO), to offer clearing of margined crypto derivatives products directly to participants rather than clearing through a futures commission merchant (FCM).

Crypto Exchange FTX Files with CFTC to Offer Disintermediated Retail Crypto Derivatives

by Practical Law Finance
Published on 24 Mar 2022 • USA (National/Federal)
The CFTC is seeking public comment on a request by LedgerX, LLC d/b/a FTX US Derivatives (FTX), a cryptocurrency exchange registered with the CFTC as a derivatives clearing organization (DCO), to offer clearing of margined crypto derivatives products directly to participants rather than clearing through a futures commission merchant (FCM).
On March 10, 2022, the CTFC issued a request for comment on a proposal from LedgerX, LLC d/b/a FTX US Derivatives (FTX), a cryptocurrency exchange, to amend its order of registration as a derivatives clearing organization (DCO) to permit it to clear crypto futures contracts and options futures contracts that are non-intermediated – that is, a futures commission merchant (FCM) need not be interposed between market participants and the DCO.
In support of its application, FTX provides a February 8, 2022 letter from its general counsel that seeks to explain how FTX's proposed approach is permitted under the Commodity Exchange Act (CEA) and CFTC regulations. This letter also notes that the proposed FTX risk-management framework is comparable to the clearing-related requirements imposed on FCMs.
A separate February 8, 2022 letter from the FTX chief risk officer explains that instead of weighing the creditworthiness of chains of intermediaries, FTX will margin all products directly against each market participant, which will enable FTX to know and manage the precise amount of risk held by each portfolio, as well as by all portfolios in aggregate, at any given moment. FTX explains that an automated system would check margin levels 24 hours a day, seven days a week and, when necessary, immediately liquidate positions in the participant’s portfolio when a participant’s margin on deposit falls below the maintenance margin level necessary to bring the participant's portfolio back into compliance with margin requirements.
According to the CFTC, there are currently15 CFTC-registered DCOs, with the majority operating under an intermediated model that includes the following three characteristics that the CFTC considers significant in the context of the FTX request:
  • The DCO only collects a portion of the possible losses the counterparty could incur while holding the position.
  • Only FCMs (and potentially some large proprietary traders) are direct clearing members of the DCO.
  • Mutualized losses are shared in a DCO default waterfall where the risk of loss from a default is shared by all clearing members.
In October 2021, FTX acquired LedgerX, a CFTC-registered DCO, designated contract market (DCM), and swap execution facility (SEF), as major exchanges begin to work more closely with the CFTC to ensure compliance with applicable US regulations.
Public comment on the FTX proposal must be submitted by May 22, 2022.
Update: On May 25, 2022, the CFTC hosted a roundtable to discuss issues related to intermediation in derivatives trading and clearing, which can be reviewed as a video on the CFTC's YouTube channel. The CFTC has also provided a transcript of the roundtable. The CFTC received numerous public comments in response to the CFTC's request, and the comment period has concluded.