Keynote Address Of CFTC Chairman Rostin Behnam At The ABA Business Law Section Derivatives & Futures Law Committee Winter Meeting

Introduction

 

Good afternoon. I am delighted to join you today in person and alongside so many of my CFTC colleagues.  Thank you to Katie Trkla and the Committee Vice-Chairs and Conference Chairs for bringing us all together again.

I would like to jump right in and talk about the Super Bowl, which is right around the corner.  For most of my life, the Super Bowl always felt like a turning point marking the transition from the long football season and winter’s most brutal months to the reporting of pitchers and catchers at spring training camps.  In many respects, this conference also serves as a similar inflection point.  For our industry, it signals a new year, a new agenda, and new opportunities.

During last year’s conference, I shared my vision for the Commission as its newly sworn in (rookie) Chairman.  I was looking forward to getting a team, having whittled down to only a pair.

Then, just as spring training got underway (a little later than usual),[1] Congress did the equivalent of calling the players to the take the field.  In an unprecedented event, four commissioners were sworn in nearly all at once.  The Commissioners did an excellent job onboarding, staffing up, getting up to speed on current issues, and providing a first glimpse into their priorities and personal interests.

Spring training was a little shorter in 2022, and so was our time to transition.  The perfect storm of events, actions, externalities, and fundamentals that made 2022 a year to remember for the derivatives markets rolled in on the heels of our earliest convenings.  We went from warm ups to playing ball in no time.  With a full roster of Commissioners, we demonstrated throughout the remainder of 2022 that our market structures, regulations, and preeminent surveillance, analytic, and enforcement programs serve the American people and markets as intended.[2]

As I recently remarked, “Without question, 2022 presented a challenging year across all commodity complexes, some more extreme than others.  In the years to come we no doubt will recall it as a period of time that put the CFTC on highest alert….”[3]  2022 gave the agency an opportunity to demonstrate domestically and abroad how we tirelessly use all available resources, leverage expertise, and develop new skills.  As always, we pursued all avenues towards ensuring that derivatives markets function with integrity and as intended, and remain open, transparent, and free from fraud, manipulation, and abusive practices.

Looking at the latest forecasts, we are already seeing that 2023 will present its own challenges and opportunities.  And 2022 revealed a few items we currently have the ability to address within our current authority.  At my direction, Commission staff has been working on proposals for full Commission consideration as our new season gets underway.  And so, I would like to turn to the Commission’s 2023-2024 agenda of rulemakings and areas of ongoing importance and deliberation before the Commission.  I will then share some thoughts on the issues that framed 2022 which will continue to develop in 2023.

The 2023-2024 Rulemaking Agenda

Having proposed a number of rules and orders in 2022, some during the earliest days of the Commissioners’ arrival to their new positions, and others that are currently open for comment,[4] I will move a handful of final rules to be voted on in 2023.  Additionally, the Commission will consider whether to codify various forms of relief previously provided by CFTC Division staff through no-action letters, which in their current forms bind only the staff of the issuing Division with respect to the specific facts, situations, and persons addressed by the letters.  And, of course, there are the business as usual requests that may come in and require our consideration regarding the issuance of orders, exemptive relief, or interpretive relief.

Our work is never done, and even our carefully crafted principles-based regulations may articulate standards that are genuinely not suitable for all.  Time-limited no-action letters may be appropriate in very limited instances where circumstances make compliance with certain regulations temporarily impossible or inappropriate.  It is never ideal to populate our space with nuanced exceptions and perceived one-offs.  However, to be an effective and responsive regulator, we must use all of our tools, and be ready to act decisively when it is necessary to do so.[5]  That said, I will always welcome meaningful advice and counsel as to the particulars of how the agency may be more attentive in fulfilling its duties.

I wholeheartedly support the agency staff and rely on their guidance regarding the most effective means to accomplish our mission and goals.  Our people are unparalleled in their skill and dedication.

We know what success looks like.  We know that fostering open, transparent, and financially sound markets that are free from misconduct and disruptions to market integrity, and in which all market participants benefit from protections when interacting with our regulated entities requires constant vigilance, review, reflection, and calculation of risks.  We are an agency that never stops moving forward.

With a full Commission, the operating Divisions have embarked on an aggressive agenda aimed at addressing issues that have arisen in the last several years.  My goal is for the Commission to consider and vote on at least 30 to 35 of the anticipated proposals in addition to all of the rules and orders proposed last year by the end of this year.  Looking at the over 30 matters for consideration, certain themes emerge: (1) enhancing risk management and resilience across intermediaries, exchanges, and derivatives clearing organizations (DCOs); (2) enhancing customer protections; (3) promoting efficiency and innovation; (4) improving reporting and data policy; and (5) addressing duplicative regulatory requirements, and amplifying international comity.

Enhancing Risk Management and Resilience

The last several years have tested the resilience of all facets of the derivatives markets and post-financial crisis reforms more generally in ways that few risk scenarios could have contemplated.  Despite a resoundingly strong response to the numerous market shocks and demonstrative resilience amid volatility, preparing to meet the most extreme, but plausible, events has taken on new meaning.  At a time when the aggressions of war, global pandemic, monetary and fiscal policy shifts, geopolitical uncertainty, cyber threats, and technology disruption are a mainstay in every risk scenario, it is difficult to envision with seriousness what could be at the end of the tail.  The global regulatory community, in concert with market participants, has appropriately debated the need for additional tools, resources, and rules to manage risk.  Accordingly, last year the Commission proposed a rule on DCO governance[6] as a step to further strengthen the clearing system.

Good governance requires a system of checks and balances.  Just as our government has three branches to ensure that no one branch can exercise too much power, good DCO (and CCP) governance has three sets of stakeholders to do the same: (1) the DCO; (2) the DCO’s clearing members; and (3) the DCO’s customers.  The proposed Governance rule is designed to enhance that system of checks and balances, providing DCOs with discretion on implementation while ensuring that clearing members and customers have their voices heard with regard to proper risk management.

This particular rulemaking has a long history, and its timing could not be more crucial.  In amending the Commodity Exchange Act, the Dodd-Frank Act[7] directed the Commission to ensure that DCOs have governance arrangements that are “transparent . . . to permit the consideration of the views of owners and participants.”[8]  In 2011, the Commission proposed rules to address this requirement[9] but failed to adopt them, and for a decade this went unaddressed.  The CFTC’s Market Risk Advisory Committee (MRAC), under my sponsorship, formed a Central Counterparty Risk and Governance Subcommittee (the “Subcommittee) to bring DCOs, clearing members, and customers together to make recommendations to the full MRAC and ultimately, the Commission, as to how they, the stakeholders, believed DCO governance could be improved.[10]

The Subcommittee’s report provided a solid foundation for the proposed rule which aims to codify areas of agreement within the Subcommittee’s report, and asked questions designed to advance the discussion in those areas where stakeholders could not reach agreement.  In coming out with a proposal of this kind, I believe the Commission broke considerable ground by promoting the proposal of rules that could be finalized within the year and allow stakeholders to begin working more closely on DCO governance while they—and the Commission—continue to explore ways to improve with the added benefit of public comment.

If the proposed DCO Governance rule is adopted, DCOs will be required to have risk management committees that allow both clearing members and customers to provide input to a DCO’s board of directors on risk management issues.  In addition, DCOs will be required to establish risk advisory working groups, which will give all clearing members and customers—not just those on the risk management committee—an opportunity to have their voices heard on risk management issues, which impact them, not just the DCO.

Turning to what is immediately before the Commission, I anticipate that we will soon publish an advance notice of proposed rulemaking and request for comments focusing on risk management programs for swap dealers (SDs), major swap participants (MSPs), and futures commission merchants (FCMs).  In the decade since the initial adoption of the risk management rules for SDs and FCMs, the CFTC has received a number of questions from SDs concerning compliance with these requirements with the most emphasis on governance and risk reporting.  The intervening decade of examination findings and ongoing requests for staff guidance, particularly from SDs with respect to SD risk management programs (“RMPs”), in my view provides an opportune time to engage in additional public discourse on this topic.  We have also observed significant variation among registrants in terms of how they define and report on the specific areas of risk enumerated in the rules making it difficult for the Commission to gain a clear understanding of how specific risk exposures are being monitored and managed by these key registrants.

Certain recent market events have only further underscored how critical effective risk management practices are.  I believe open and transparent engagement with registrants is an important mechanism in ensuring the Commission’s rules are comprehensive and effective—and that the Commission is receiving the appropriate kind of risk data to adequately assess the risk management practices of its registrants.  Among the many areas of inquiry will be whether the Commission ought to consider harmonizing the RMP regulations with the risk management regimes of any prudential or other regulator, or further incorporate elements of risk management requirements applicable to other CFTC registrants.  Additional requests for comment will seek input on enumerated risks, specific risk management considerations, whether certain definitions are needed, and if so, what they should include and whether there is opportunity for harmonization.

One particular risk that will receive its own rulemaking is cyber.  The growth of cybersecurity threats to financial institutions is well-documented and widely recognized as an important and increasingly urgent problem.  One the Commission is actively dealing with as we sit here today.[11]  As we are experiencing this week, market participants registered with the Commission have not been immune to these threats.  The Commission is aware of cases where our registrants have become victims of phishing attacks or used third-party vendors with weak controls, compromising customer money and information.[12]

The Commission has, of course, brought enforcement actions against these firms for failures to supervise related to implementing and following cybersecurity policies and failures to disclose the occurrence of cybersecurity attacks.[13]  While many of our registrants are subject to cyber requirements through prudential and other regulatory regimes, there is a greater role for the Commission to play in fostering sound and responsive cybersecurity practices among our registrants.  Specifically, I believe that by establishing thoughtful and adaptive CFTC-specific cyber requirements for FCMs and SDs, and engaging deeply with our registrants--as we do on all matters--to ensure their continued compliance with them, the CFTC can help raise standards that will ultimately improve operational resilience across the financial sector and serve to better protect customer assets.  To that end, I support the development of a CFTC operational resilience rule for FCMs and SDs that is designed to adapt to the risk profiles of those registrants and the ever-evolving nature of the cyber risk landscape while being mindful of how it intersects with other existing cybersecurity requirements.

As recent events have brought home, the industry’s necessary and increasing reliance on third-party service providers creates a major source of risk for participants in our markets, a risk that is only promised to rise with growth of virtual access and cloud-computing.  Accordingly, I think it imperative that any cyber rule we develop provide CFTC registrants guidance on their oversight obligations with respect to critical third-party service providers to help ensure their risk management practices are adequately designed to preserve the integrity, availability, and confidentiality of critical systems and information.  Accordingly, the Market Participants Division (MPD) will issue guidance complimentary to a cybersecurity rulemaking regarding the use of third-party service providers to satisfy compliance obligations.  Given the circumstances we are facing this week, this guidance will serve markets well in the future.  I anticipate that this guidance will seek to harmonize and be consistent with the National Futures Association’s (NFA’s) Interpretive Notice on Member’s Use of Third-Party Service Providers.[14]

Many more of our anticipated rulemakings aim to further risk management and resilience, and many will naturally focus on DCOs.  The Commission will seek to codify current no-action relief addressing FCM treatment of separate accounts by the same beneficial owner for purposes of margin requirements[15] and guidance addressing DCO recovery and resolution plans.[16]  The Commission will consider additional proposals to revise and incorporate certain requirements currently applicable to Systemically Important DCOs (SIDCOs) and DCOs who elect to comply with the same regulatory requirements as SIDCOs into a single subpart applicable to all DCOs, and to clarify and address certain DCO-specific issues and provisions in Part 40 of the Commission’s regulations.

Enhancing Customer Protections

Over the past decade, many financial markets have experienced strong growth in participation by retail participants.  On the demand side, improvements in technology have been a key driver, with more data and functionality available via apps on smart phones.  On the supply side, exchanges are marketing to individual traders and offering them new products, such as micro contracts with a small fraction of the notional size of more traditional contracts.  The CFTC’s Office of the Chief Economist has estimated that retail trading volume in futures contracts now averages about 50% higher than during the pre-pandemic period.

Many of my remarks since becoming Chairman have included some mention of increased retail participation in our jurisdictional and related markets along with my commitment to ensuring that the rise of retail participation and the exchanges, intermediaries and innovators who are eager to meet demand for products and services are appropriately brought into the regulatory fold.[17]  In addition to directing staff to analyze risks and consider what additional protections are needed for retail market participants, I have directed staff to begin putting forward proposals that will have immediate and direct impacts for retail customers in our markets.

With respect to our commodity pool operator and commodity trading advisor (CPO/CTA) registrants, it is time to consider making meaningful updates to certain regulatory exemptive provisions.  The Commission will soon consider proposed amendments to raise the asset tests for status as a qualified eligible person (QEP) to reflect inflation since the early 1990s and appropriately define who is a retail pool participant or advisory client.[18]  Commission staff will also propose codification of routinely provided exemptive letter relief for account statement reporting deadlines for certain commodity pool operators.[19]  Codifying this relief would ensure pool participants continue to receive more frequent and complete account statement reporting.

Finally, over the last 30 years, reliance upon regulatory exemptions provided in Commission regulation 4.7 has expanded to comprise the vast majority of registered CPOs and their listed commodity pools.  I am increasingly concerned that many investors are not receiving the full protections of Part 4 as a result.  The need to make much-needed updates to Regulation 4.7 provides an opportunity for the Commission to address this potential gap in customer protection through considering an amendment to establish minimum disclosure requirements for 4.7 exempt pool and trading program investments.  While many CPOs and CTAs already provide some disclosures through Private Placement Memorandums and other publications distributed to potential investors, I am interested in establishing a threshold level of customer disclosures in the exempt CPO/CTA investment markets that would provide basic information on fees, conflicts of interest, description of the investments, and other disclosures I believe all investors are entitled to, regardless of their sophistication.

Again, this is just a snapshot of what we have ready in the hopper.  I anticipate that as the year progresses, we will see several more proposals and guidance aimed at customer protection and retail participation from our operating divisions in addition to other initiatives from our Office of Customer Education and Outreach.

Promoting Efficiency and Innovation, et al.

Promoting efficiency and innovation is inexorably linked to improvements in data reporting and policy.  Starting again with our DCOs, the Commission will consider finalizing proposed amendments to reporting and information regulations applicable to DCOs.[20]  The proposed amendments address certain issues identified by the industry and through our experience with DCO compliance.  The proposed amendments would eliminate the need for, and otherwise supersede, existing staff-level no-action, interpretive relief, and guidance and make additional changes to or clarification for certain Part 39 regulations.  Among other things, the amendments seek to clarify DCO reporting obligations to ensure that the Commission receives the information needed to carry out necessary supervision.[21]

The Division of Clearing and Risk (DCR) will also propose for Commission consideration an exemptive order pursuant to Section 4(c) of the Commodity Exchange Act (CEA or the “Act”),[22] often referred to as the “public interest exemption,” aimed at granting targeted relief for options and futures on precious metal commodity-based ETF shares where: (1) assets of the ETF consist entirely of precious metal commodities and the ETF is not a leveraged ETF; (2) the ETF is traded on a national securities exchange registered with the Securities and Exchange Commission (SEC); and (3) the options or futures, as applicable, are cleared and settled by an SEC-registered clearing agency.  The Commission has issued similar orders in the past, with each tied to a particular ETF.[23]  This exemption would permit the petitioner to clear additional ETFs within the criteria thereby eliminating the need for, and practice of, seeking relief on a fund-by-fund basis.

DCR will also be continuously working through DCO, designated contract market (DCMs), and SEF applications and requests for amended registration orders that raise novel clearing structures and issues requiring heightened review and scrutiny, especially where such structures would incentivize increased retail participation.  Additionally, staff has noted an uptick in proposed models for SEFs with a prime broker component that arguably fall within the DCO definition and therefore would trigger registration requirements.  We are considering how the Commission may most effectively clarify circumstances where integrated models may trigger dual registration requirements.

As this community knows well, the Commission is bound by the Commodity Exchange Act to be responsive to all requests via application.  And the Commission’s response must be anchored in the law, and defensible in a court of law.  As Chairman, I will continue to direct staff to engage with thoughtfulness and seriousness, regardless of the applicant.  We are, in short, agnostic to the entity submitting the request, and act only in concert with what the law requires.

The intermediary space will also see proposed codification of staff no-action relief addressing swap dealer business conduct standards and documentation requirements while SEFs will see proposed rules aimed at harmonizing rules with developments in the SEF markets.  The lineup of potential rulemakings for SEFs address longstanding concerns with Made-Available-to-Trade or “MAT” determinations, uncleared swap confirmations, conflicts of interest and governance, confirmation requirements for SEFs, audit trail requirements, and comparability determinations for exempt SEFs for UK-based multilateral trading facilities and organized trading facilities.  Several of the proposals would codify existing no-action and other letters.  The Division of Market Oversight (DMO) is also set to revisit regulations implemented pursuant to the Ownership and Control Report or “OCR” final rule[24] for which no-action relief currently applies.[25]

No rulemaking agenda should be complete without data and reporting improvements.  In addition to those already mentioned, as a follow on to the new swap data reporting rules implemented in December,[26] the next major step towards data standardization and international harmonization is adoption of the Unique Product Identifier (UPI) to represent the underlying product of swap transactions.  After much coordination, we are nearing the finalization of an order designating UPIs issued by the Derivatives Service Bureau Limited, as designated by the Financial Stability Board.  Additional proposals will address updates and revisions to block and cap trade size and amend Part 17 to modernize data submissions and clarify reporting matters.

Within the remaining themes I mentioned, you can anticipate the Commission considering multiple comparability determinations addressing cross-border matters relating to capital and financial reporting, swap trading relationship documentation, and uncleared margin[27] in addition to considering petitions for exemptive orders relating to foreign futures and options transactions under Commission regulation 30.10.[28]

Getting it Done

That was a bit of sprint through the extra-inning game I have planned.  We’ve spent the last year in training, and I am excited to engage with my fellow Commissioners, get their feedback and improve our efforts with their contributions.  The public comments will also prove most critical to our analyses. I look forward to kicking off these next steps in improving our rules, and creating more resilient, transparent and vibrant markets.

The Current Climate

While agendas are always exciting business, they are more akin to the scoreboard of our progress, marking in a deceivingly simplistic way the hundreds if not thousands of hours of effort that went into earning a few highlights.  And, even in spite of the effort, some things never make it to the final out.  Even still, the CFTC seems to make it into the headlines, for what it is doing and, in some cases, what some believe, either correctly or incorrectly, it is not doing.  We will remain vigilant, nimble, and continue to push harder as we move forward on this journey in fulfilling the agency’s mission.

Climate

The Commission both domestically and in international workstreams is continuing to engage through the Climate Risk Unit (CRU) on the role of derivatives in understanding, pricing, and mitigating climate-related risk, and support the orderly transition to a low-carbon economy through market-based initiatives.  In June, the CFTC held its first ever Voluntary Carbon Markets Convening[29] which provided market participants and other stakeholders in the voluntary carbon markets and the U.S. derivatives markets a venue to share their perspectives on the challenges and opportunities.  To ensure that we continued the trajectory, remaining transparent and seeking feedback from a wide range of stakeholders, the Commission immediately followed it with a Request for Information (RFI) on climate related market risk.[30]

The RFI sought feedback on all aspects of climate-related financial risk as it may pertain to the derivatives markets, underlying commodities markets, registered entities, registrants, and other market participants.  It also asked questions specific to data, scenario analysis and stress testing, risk management, disclosure, product innovation, voluntary carbon markets, digital assets, greenwashing, financially vulnerable communities, and public-private partnerships and engagement.  The comment period closed in October and the CRU is finalizing a comment summary for Commission consideration.

The issues highlighted at the Convening and raised through the RFI are critically important and require diligence, time, and patience to ensure we are getting—whatever we do—right, through consensus building and data driven solutions that are within the legal remit of the Commission.  Extreme weather events and climate change contributed to the confluence of events that defined the commodity roller coaster of 2022, and I have a received a number of inquiries from Congress and outside groups about what role the CFTC has in the voluntary carbon markets.  With several carbon offset futures listed and cleared with CFTC registered entities, the CFTC is naturally tied to the underlying contracts, but our intersection is indirect as we do not have direct oversight of the underlying VCM.  This growing market needs oversight, and I intend for the Commission to do whatever we can to foster these markets while acknowledging our statutory mandate.

The resilience and integrity of the VCM as it scales to meet increasing demand for carbon offsets will rely on both public and private sector initiatives.  The private sector has been hard at work over the past couple of years on creating standards to scale the supply of high-integrity carbon offsets and shape firms’ demand for them.  It is equally important that the relevant authorities in the public sector develop frameworks that will promote markets that operate with integrity and resilience.  I am proud of the work that the IOSCO Sustainable Task Force Carbon Market Workstream undertook in 2022 to issue a 90-day public consultation on 14 key considerations that relevant authorities may consider as they seek to shape a VCM market structure that supports fair, transparent, and orderly trading.[31]  I also look forward to the public’s feedback on the workstream’s recommendations for establishing sound compliance carbon markets.  The comment period for both of these consultations ends on February 10th.

The CFTC is here as a market regulator to ensure, where appropriate, that VCMs grow in a responsible way, with appropriate supervision and necessary guidance and guardrails.  I am pleased that the Commission’s efforts to date demonstrate very intentional steps towards increasing U.S. participation in international efforts.  But we are still in the early innings and these markets require a new way of thinking and present issues requiring careful examination.  I look forward to sharing the results of the RFI and formulating an agenda for next steps in 2023.

Crypto Catch-all

I will be brief in my remarks on crypto since I have repeated myself often and my position has not changed: there remains a gap in crypto cash market regulation for non-security tokens, and I believe the CFTC is well positioned to fill this specific gap if Congress so chooses.[32]  The crypto market was shaken to its core last year, on several different fronts.  In my view the bankruptcies, failures, and runs only validate that action is needed.  The ecosystem is vast, will not vanish, and needs comprehensive legislation.  The cryptoverse is not a closed system.  Regulation is necessary to protect customers and to prevent failures which cannot predictably be contained within any boundaries across the domestic and global financial markets.  Regardless of whether one or many occur in 2023 or 2033, we must act.  There is a new Congress, and I will continue to engage and provide technical assistance to draft legislation, as requested.

Building on my earlier point regarding requests, the CFTC will also continue to engage with new stakeholders.  The agency has processes and guiding core principles, and we are careful, deliberative and patient.

When it comes to novel products like crypto, the Commission has established heightened processes to guide internal deliberations.  In fact, my first MRAC meeting as sponsoring commissioner in 2018[33] highlighted the development of those processes.  Though somewhat critical of their development alongside the first self-certification of Bitcoin futures and binary options contracts,[34] I commended then-Chairman Giancarlo for releasing backgrounders on self-certification of bitcoin products[35] and on the oversight of and approach to virtual currency futures markets,[36] recording a podcast roundtable with CFTC leaders on Bitcoin,[37] and launching a Bitcoin education webpage.[38]  The source of my criticism was the diminutive interpretation of that process.  I argued, that, “While the self-certification process does not expressly provide for public input, that does not mean that public input in the process of launching new and novel products is impossible or undesirable.  To the contrary, dialogue between the Commission, the exchanges, and market participants is vital to the process.”[39]

As a commissioner and now Chairman, I have encouraged and incorporated public input to ensure that efforts to engage in heightened scrutiny and evaluation do not fall flat.[40]  In addition to using the MRAC and now the Agriculture Advisory Committee as a forum, I have called for roundtables and convenings, and encouraged staff to seek public comment on matters before and of direct interest to the Commission.

Now, as this audience may know, there are several digital platforms under CFTC oversight that offer digital asset derivatives.[41]  The Compliance Branch within the Division of Market Oversight has reviewed each of the platforms offering digital asset products for recent and upcoming Rule Enforcement Reviews, System Safeguards Exams, as well as written requests DMO has sent to platforms asking them to demonstrate compliance with requirements under Regulations 37.5 and 38.5, which address compliance with core principles for SEFs and DCMs.  The Compliance Branch also conducts regularly scheduled meetings with each registered entity either quarterly or biannually (depending on the size of the exchange).

Regarding new products, in 2018, DMO and DCR issued a joint advisory addressing virtual currency derivatives product listings.[42]  Though not a compliance check-list, the advisory reminds exchanges and clearinghouses of their self-regulatory obligations for the markets they operate and clarifies the Commission staff’s priorities and expectations in its review of new virtual currency derivatives to be listed or to be cleared, regardless of the process chosen for doing so.  Additionally, although not required for self-certified products, platforms have continued to reach out to DMO’s Product Review staff prior to listing new digital asset products.  Staff’s review of those products primarily focuses on Core Principle 3[43] compliance which addresses susceptibility to manipulation.  The platforms also share draft information sharing agreements with staff.

Relatedly, DMO is currently considering whether DCMs that list cryptocurrency-based derivatives contracts, and/or are affiliated with cryptocurrency spot markets, should adopt policies and procedures to restrict the trading by: (1) DCM employees in affiliated cryptocurrency spot markets; and (2) cryptocurrency spot market employees on affiliated DCMs.  DMO Compliance and its Chief Counsel branch staff recently held meetings with several DCMs that either list, or plan to list, cryptocurrency-based futures contracts, and/or are affiliated with cryptocurrency spot markets, to obtain information relating to their employee trading restrictions.

The Cop on the Beat

Any discussion of the digital asset space seems to roll right into enforcement.  The DOE’s effectiveness in holding individuals and institutions accountable promotes confidence in U.S. derivatives markets, which continue to be the premier mechanism for global price discovery and risk management.  Demonstrating our continued commitment to protecting customers and ensuring market integrity, in FY 2022, the CFTC obtained orders imposing over $2.5 billion in restitution, disgorgement and civil monetary penalties either through settlement or litigation.[44]

Among the 82 actions filed in 2022, in May, the CFTC resolved charges against Glencore International A.G., Glencore Ltd., and Chemoil Corporation (collectively, Glencore), for manipulative and deceptive conduct—including conduct relating to foreign corruption—that undermined the integrity of U.S. and global physical and derivatives oil markets.[45]  The conduct, which spanned from at least 2007 to 2018, included manipulation or attempted manipulation of four U.S. based S&P Global Platts physical oil benchmarks related to futures and swaps.  Glencore is one of the world’s largest commodity trading firms and the $1.186 billion penalty represents the highest civil monetary penalty ($865,630,784) and highest disgorgement amount ($320,715,066) in any CFTC case.

In September, the CFTC settled charges against Beijing-based COFCO Corp. and Chinatex Corp., Ltd, for wash trading, position limit violations, and reporting failures.  The speculative position limit violations occurred while trading ICE Cotton No. 2 futures contracts.  In a separate action, ICE Futures U.S. settled a disciplinary action against Chinatex and an affiliate for trade practice violations, conduct detrimental to the exchange, unauthorized use of trader identification information, position limit violations, misuse of a hedge exemption, and failure to supervise.[46]  As commodity prices remain volatile, our enforcement and surveillance tools will remain the most effective mechanism to ensure our markets remain reliable sources of price discovery and serve their risk management function--even in times where market stress and new and nascent technologies and products may entice market participants into exploring strategies and outright schemes that do not reflect or interfere with legitimate market forces.

With respect to enforcement in the digital assets space, the Commission continues to act, using all of its authority under the CEA.  To date, the Commission has brought 69 enforcement actions involving digital assets that are commodities in interstate commerce, swaps, and other derivatives.  Such cases comprised more than 20% of the 82 actions filed last year.  Given our very limited authority, these results demonstrate the outstanding capacity of our enforcement staff.

Quite simply, reviewing the landscape of digital asset cases, the CFTC has brought important, precedent setting cases against those who illegally offer derivatives or leveraged, margined or financed digital asset products to US customers or operate within the United States.  For those digital asset firms and platforms operating in violation of registration or designation requirements under the CEA, the Commission has charged them with failure to register as a DCM, FCM, or SEF along with any other regulatory failures, such as failing to meet AML requirements—regulatory requirements that are designed to protect customers and ensure market integrity.

Recently, the Commission brought the first enforcement action against a decentralized finance trading protocol that had transformed into a decentralized autonomous organization, a DAO, offering leveraged and margined retail commodity transactions to the public.[47]  In making the calculated decision to be a DAO, the DAO claimed that its status as a DAO rendered it enforcement-proof.  As we alleged, the leveraged and margined transactions on the DAO’s trading protocol allow members of the public to bet on the price performance of various digital assets.  Under the Act and Regulations, such transactions can only be lawfully offered on a designated exchange; doing so, and utilizing registered FCMs, is critical to protecting members of the public due to all of the customer protection requirements attendant to registration.  In that action, the Commission has prevailed on whether service had been made on the DAO by service through a chatbox on the DAO’s website, and the federal court held the DAO is in fact an unincorporated association which can be sued for alleged violations of law. That litigation is ongoing.

The Commission also continues to tenaciously combat the pervasive fraud and manipulation that is happening on spot digital asset platforms, which goes to the heart of the issue of unregulated crypto cash markets.  Following the collapse of FTX (a centralized digital asset exchange), the Commission brought a fraud action against FTX, its co-founder, and Alameda (a digital asset trading and investment firm and market maker on the exchange) alleging misappropriation of customer funds, and amended that action to add two other key individual defendants: the CEO of Alameda and the co-founder of Alameda and FTX.[48]  Less than three weeks later, the CFTC brought a one-of-a-kind manipulation and fraud action involving an individual’s manipulation of pricing “oracles” on which a trading protocol relied to determine the value of swap positions on the protocol, artificially inflating his swap positions.[49]  The Commission action also charges fraud because the defendant engaged in the manipulation to inflate his holdings in order to unlawfully obtain digital assets pooled in a lending program.

These cases show that the Commission and its staff are committed to using the full breadth of the Commission’s authority under the CEA to protect the public by addressing the illegal offering of transactions in digital assets as well as fraud and manipulation in connection with digital assets.

Of course, our enforcement staff are All-Stars, and I know that they are already working towards another strong year of precedent setting cases.  For my part, as our budget increases, I will continue to support growing our enforcement and surveillance teams.

Data

Included within that spending will be continued expansion of our use of data through investments in our Division of Data (DOD) resources and personnel.  The tools we are developing to support surveillance and enforcement include machine learning, NLP (natural language processing), and AI (artificial intelligence).  These are powerful tools that make some of the policy ideas suggested only a few years ago to address automated trading and pattern recognition obsolete.  We have to be looking forward, using technology to our advantage, and making the CFTC a world class agency with the best tools possible.  We will not revisit stale ideas, that do nothing more than cement us in the past and relegate the agency to always playing catch up.  My office is fully engaged, and the mission for DOD is clear: focus on substance, law, efficacy, and getting the bad guy!

Conclusion—Let’s Get Back to the Superbowl

By now you are ready for half time or the seventh-inning stretch, or maybe just a giant cookie.  I wanted to talk to you today because I am excited to take the agency far this year.  I think we can accomplish a tremendous amount; the conditions are looking good.

But before I field a few questions, I want to return to the Superbowl.  The best part of the Superbowl (in some peoples’ opinions) are the commercials.  Putting aside the crypto commercials of 2022, and taking a further step back to 2021—when both the Superbowl and my naming as Acting Chairman of the CFTC had historically low attendance, a series of sponsored advertisements by Rocket Mortgage captured our attention.[50]  In the commercials, Tracy Morgan guides a family of potential homebuyers who are “pretty sure” they can afford a new house through a series of hysterical and hyperbolic situations to explore the difference between being “pretty sure” and “certain.”  In one situation, Tracy and the family are in an airplane.  Tracy pushes the father out of the plane saying he is “pretty sure” that the father has a parachute on his back, when it is very clearly a child’s backpack.  Indeed, the daughter simultaneously exclaims that her equally adorable backpack has a sandwich in it.

In another, Tracy cuts down a hornets’ nest that lands on the father’s head, remarking that he’s “pretty sure those hornets aren’t the murdering kind.”  In the end, the now traumatized homebuyers agree that, when it comes to homebuying, they would rather be “certain” than “pretty sure.”

The ads were fantastic as they were not only simple and memorable, but invited us into each scenario, compelling us to choose between our two options of “pretty sure” and “certain.”  With each extreme situation, we increasingly realize that being “pretty sure” about something could invite substantial—but largely preventable—risk, and that in many situations, getting closer to “certain” often requires little more than basic due diligence, situational awareness, and accountability.  To avoid being stung by hundreds of hornets—potentially the murdering kind—don’t stand under a hornets’ nest, ever.  That’s just common sense.  But that’s really the point.

The messages in these clever ads resonate.  The words we use matter.  Certainty is better.  Be a thoughtful and responsible participant.  Being reckless in, or unfamiliar with, your environment and circumstances can get you in trouble.  Preventing risk and discouraging harmful behaviors and bad actors requires communication, cooperation, accountability, transparency, and reliance on relationships.

I’m thinking about this because, in responding to the latest issues, events, inquiries, and market conditions, it can be challenging to work together, to build trust, to find clarity.  We have to remember that a hyperbolic response may not bring about the certainty we are looking for.

What we are seeing now in the headlines appears to be rooted in a lack of risk management or the absence of a structured compliance function.  It may be that we need to assert our authority and regulatory oversight, tempered by the need to be clear in what are well-defined boundaries of our authority, but firm enough to incite a culture of compliance.

Looking out at this room, I am reminded that as a regulator and as a member of this industry, relationships, cooperation, and coordination continue to be top priorities.  We will reach out, we will communicate, and we will do our best to get you, your clients, and your firms from “pretty sure” to “certain” when it comes to your regulatory and compliance responsibilities.  Our goal is to make sure you have a parachute and not just a backpack.  I hope that when you think of us, we are the kid waving the sandwich at you before you jump, not the guy cutting down the hornet’s nest over your head.  Thank you.

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