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CFTC Issues Guidance on Virtual Currency Derivatives Contracts
Practical Law Legal Update w-014-8877 (Approx. 5 pages)
CFTC Issues Guidance on Virtual Currency Derivatives Contracts
by Practical Law Finance
| Published on 24 May 2018 • USA (National/Federal) |
The CFTC issued an advisory on virtual currency derivatives that clarifies key areas requiring enhanced attention for clearinghouses and exchanges when listing a new virtual currency derivatives contract.
On May 21, 2018, the CFTC issued an advisory on virtual currency derivatives that clarifies key areas that require enhanced attention from clearinghouses and exchanges when listing a virtual currency derivatives contract for trading on a designated contract market (DCM) or swap execution facility (SEF), or when clearing a virtual currency derivatives contract through a derivatives clearing organization (DCO).
Under CFTC Regulations 40.2 and 40.3, prior to listing new contracts, including virtual currency contracts, DCOs must either self-certify that the contract complies with the Commodity Exchange Act (CEA) and CFTC regulations, or submit the contract for CFTC approval (see Legal Update, CFTC Announces Bitcoin Derivatives Self-Certification Process and New Bitcoin Contracts on Three Futures Exchanges).
The advisory reflects the CFTC's expectations when reviewing newly listed virtual currency derivatives contracts, which include:
- Enhanced market surveillance by the listing exchange, including:
- implementation of a market surveillance program that encourages sharing of relevant data – including the identity of the trader, prices, volumes, times, and quotes from relevant market makers and traders – between the underlying spot markets and the exchange;
- a heightened level of real-time monitoring of trading activity on the exchange's electronic trading platforms that includes continuously monitored relevant data feeds, such as price and volume, from the spot markets;
- visibility into spot markets and expectations that spot markets follow regulations similar to federal know your customer (KYC) or anti-money laundering (AML) regulations.
- Close coordination with the CFTC surveillance group, including:
- regular discussions and information sharing between the listing exchange and CFTC staff in order to monitor for potential manipulation or fraud;
- the provision of relevant data to allow the CFTC staff to conduct its own surveillance upon request.
- Large-trader reporting, with the reporting threshold set at five bitcoins (or the equivalent for other virtual currencies) for any virtual currency derivatives contract. The advisory notes that this will cover 70-90% of the total open interest in virtual currency contracts. The CFTC will make adjustments to this threshold as the market develops.
- Broad outreach to members and market participants, including:
- comment solicitation on a broad scope of issues beyond those relating to the contract's terms and conditions and susceptibility to manipulation;
- consultations with members and relevant stakeholders beyond those interested in trading the new contract;
- the inclusion of an explanation of substantive opposing views and how the exchange addressed these views, in addition to the explanation and analysis of the contract and how the contract complies with the CEA and CFTC regulations (see 17 CFR 40.2(a)(3)(v) and 40.3(a)(4)), with its submission to the CFTC for the listing of the contract (for information on the self-certification process requirements, see Legal Update, CFTC Announces Bitcoin Derivatives Self-Certification Process and New Bitcoin Contracts on Three Futures Exchanges).
- DCO risk-management and governance for cleared virtual currency contracts, including:
- proposed initial margin (IM) requirements, submitted by the DCO;
- revised IM requirements and supporting data submitted by the DCO, if necessary;
- information related to the governance process for approving the proposed virtual currency contracts, including explanations of how the DCO considered the views of clearing members in approving the proposed contract and its response to any dissenting views;
- CFTC review of the DCO's adherence to its internal governance procedures for new contract approval.
The advisory is the latest among CFTC efforts to provide risk-management guidance in the virtual-currency market to help clearinghouses and exchanges provide proper safeguards and vetting for virtual currency derivatives.
In October 2017, the CFTC launched LabCFTC, a FinTech initiative, and in December 2017, the CFTC announced the self-certification process for bitcoin derivatives and reported new bitcoin contracts on three futures exchanges (see Legal Updates, LabCFTC Issues Primer on CFTC Regulation of Virtual Currencies and CFTC Announces Bitcoin Derivatives Self-Certification Process and New Bitcoin Contracts on Three Futures Exchanges).
The CFTC has also emphasized an enhanced focus on virtual currency derivatives products (see Legal Update, CFTC Announces Heightened Review of Bitcoin Futures Products).
For more information on virtual currency regulation, see Practice Note, Virtual Currency Regulation: Overview.