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CFTC's vision for crypto-regulation

2022-06-09

Consensus 2022

Rostin Behnam, Dawn Stump, Michael Casey

# Introduction

MC: For those who don't know that much about what the CFTC does, Chairman Behnam, could you level step and set the stage about what the CFTC is all about and what its role in crytpo has been?

RB: Sure, and then I can ask Dawn to correct me. It goes back to 1975, which was an inflection point in financial markets that drove the agency to be spun out of another US agency. We have a new product with crypto that we're not used to seeing. These are financial contracts that are derived from underlying commodities like soybean, oil, wheat, silver, palladium, other metals, and also financial contracts. These are hedging tools. Mostly institutions trying to hedge risk like rate risk, foreign currency risk, etc. We have a fair amount of retail clients in the markets, and we expect that to grow. With respect to crypto, for the number of years in the past that we have seen this emerging market evolve over the past 5 years... We have seen crypto futures for bitcoin/ether since 2017, and we are starting to see native crypto firms buy through M&A activity CFTC-licensed exchanges and clearinghouses which I think is a clear signal that the demand and desire for futures products, even just swap products, so that people can get exposure to derivatives products and manage volatility, and then use it as a store of value. A lot of institutional investors are seeing this as favorable and wanting to participate in these markets.

DS: I think Chariman Behnam is right that we're at an inflection point. I recently left the CFTC, but I was there when we began to see the interest in the crypto industry wanting to seek out regulation and legitimize what they were doing and encourage people that it was well regulated and something that they could feel safe about engaging in, and I think we were really fortunate that we had a really good dialog with many people. The CFTC regulates futures and swaps, but people want the CFTC to do more. I think the CFTC is the best kept secret in Washington DC. It functions in my humble opinion better than some other regulatory agencies and I think we should be very proud of that. I think it's really good that people want to have the CFTC involved in their markets.

MC: It sounds like there are CFTC fans in the audience. I didn't know there would be regulatory groupies. Amazing. That's a good segue here because, Stump mentioned that some people want the CFTC to do more. We recently saw a bill introduced by Senator Lummis and others to give a greater way to CFTC in its oversight of cryptocurrencies and its technology, and in particular for cash markets which is a fairly big departure. Is that what you guys want? Are you looking for more authority? And if so, why is that the way to go?

RB: It's not necessarily that we're looking for more authority. It's about what my responsibility is as a regulator. We have a growing emerging market that has a lot of risk and volatility, and it has a lot of promise in many respects. From a market regulator's perspective, as we saw trading venues develop over the past decade, we have seen demand for retail and institutional investors to get exposure and trade these products. When I see these trading platforms, I see many of the characteristics I see in our other regulated markets like swaps and options markets. It's a departure, yes, we're a derivatives regulator and we don't regulate cash transactions or agricultural or energy products. But this market that we're seeing is retail oriented and highly speculative; the traditional commodity markets are wholesaler markets like grain elevators or commercial end-users buying and selling large quantities of commodities. Crypto is different, retail oriented and highly speculative. Ultimately it's about using the fantastic infrastructure we have in Washington which is filled with experts that understand how markets work. From the CFTC's perspective too, an understanding of how commodities work. As we see these things change and come and go, I think it's important. The bill does this well as a starting point: draw some lines around which coins are commodities and which coins are securities. During an event yesterday, I said for those who are commodities, not withstanding the fact that we're historically a commodity derivatives regulatory, we think we should also regulate cash digital commodities and leverage our expertise on the commodity side and the market side and using that expertise so that we can bulid the framework of CLOBs, post trade reporting information flows, market surveillance, and making a level playing field so that everyone can get the information and exposure that they need.

MC: We made that last part echo so that those in Washington hear those twice.

DS: Chairman Behnam both worked on capitol hill and owrked on legislation. We both know that this bill will not look exactly like it does today when it is done. It is comprehensive and deals with commodities and securities. It's so important to have this bill start this conversation. I think what everyone is hungry for is some clarity. When I was at the CFTC, there was so much confusion and people just assumed that we regulated the cash commodity because we were a commodity regulator, but no we don't have authority to regulate actual physical bitcoin. Some people at the SEC may believe they have that authority, their authority might be broader, but I think it's questionable that the Howey test that the SEC applies is a good fit to the markets is unclear to me. These current authorities that these agencies have is not a perfect fit for current market conditions and we need legislation to help clarify who should be doing what. Some people ask me about the CFTC's fight with the SEC, but I don't think there's a fight. We have a great relationship with the CFTC, but we're always trying to take a statute that was designed years ago for things like oil and interest rate swaps or corn or cattle and sometimes the CFTC's operating statute is flexible enough that we can make it work for in-flight bitcoin futures, but it doesn't work for cash bitcoin and so we need Congress to provide some clarity. I think everyone here is hungry for that clarity. The industry would like to have a well regulated market, but there's a lot of questions with regards to who is doing what. Sometimes the CFTC creates its own quirkiness, because we bring enforcement cases that are relevant to cash bitcoin, many of which I voted for. The CFTC can bring suit to ensure that there is no fraud in the actual market, because that fraud influences the derivatives markets that the CFTC has authority to oversee, but in doing this the public was confused that the CFTC was bringing enforcement cases and I never wanted the public to have a false sense of security that the CFTC was regulating these cash physical transactions.

MC: You're touching on something interesting. CFTC's actions are sometimes criticised for using enforcement as a means of establishing regulation. In the midst of that, we're still using the 1933 Act to determine securities which is an act of regulating by enforcement and creating expectation around that. At the SEC, Gensler might say no it's clear and everything is potentially a security, and there are some people who will say that's not necessarily as well defined as Gensler thinks. What needs to happen to establish that clarity? What exactly needs to be in place in terms of legislation?

DS: When we talk about the cash space, there's going to have to be a distinguishing definition. The definition that seems to be coming up frequently is the distinction between commodity and security. In the past, I thought the distinction was misleading, but in the context of who is going to regulate the cash market there must be a distinction established by Congress. Who is doing what? Commodities, or securities? Sometimes they can morph from being a security into something else; I haven't read the legislation in great detail yet, but I hear that they provide a potential path for how products might morph into another format and get regulated by a different regulator if that occurs. The CFTC works with the SEC on a number of matters. I was on Capitol Hill when Dodd-Frank was written, and there were many conversations about who was going to regulate what parts of the OTC swap market and both the CFTC and SEC were talking about regulating pieces of that. These conversations can be done, but it rerquires everyone to roll up their sleeves, and I think we will all be better served if we write some rules and clarify what the expectations are in advance of continuing down this enforcement path.... To the extent that the CFTC is enforcing cases relative to failures to register with the CFTC or failures to be regulated by the CFTC, I think the regulator owes the marketplace more clarity before going down that path.

RB: Dawn and I disagree on this a bit. When we were both at the commission, we talked about this a fair amount. In principle, what we have to be very careful about is how we push enforcement. We certainly don't want to set policy by enforcement, but I think this is where we disagree and the rules are the rules and the law is the law and we implement rules based on the law and there needs to be an expectation that market participants, safeholders, exchanges, clearinghouses, emerging crytpo platforms or intermediaries in the crypto space introducing a retail customer to a market, we need to understand what the purpose of the law was and how it was drafted not withstanding the intention decades ago did not have in mind the idea that a digital asset would evolve and emerge as a commodity. I think we need to have an expectation that individuals in the market are going to understand and know what the rules of the road are, and whether or not they become subject or could become subject to a compliance requirement. Just reiterating, fraud manipulation is a no brainer. We have that authority and we use it a lot. But the compliance requirements do become a little bit of a grey area; my expectation is that we brought enough cases in the last 6-12 months and the information out to the stakeholders were clear about what our expectations are when you have a commodity and take actions that might affect a customer or registration requirement.

MC: If this goes forward, the development of this bill and it gets passed, your authority is expected to increase. You'll need a lot more staff? You have regulation and enforcement actions. Is the CFTC ready to take this on?

RB: In the bill, there is a provision that would authorize the CFTC to implement a user fee which is not unique to financial regulators but is unique to the CFTC. We're one of the few financial regulators that doesn't currently have a user fee. Essentially it would be assessing a fee-for-service which would allow us to do our job and do what the statute requires. If we were to be granted this authority through an amended draft of whatever this bill becomes, then we would have a user fee to help fund us and we would need to staff up and get experts from this space. We have staff that have some of this expertise, but there's no doubt that it will change the face of the agency in many aspects of what we do. We don't need to reinvent the wheel; let's use existing infrastructure that we have within the policy space and leverage that, we have to evolve with markets and technology. We ourselves in Washington-- disruption with technology, and this is an opportunity for us to leverage our expertise to help support the market where there is an opportunity and also protect customers.

MC: Whether or not you need to seek appropriations for this, there's still political strife that goes on when you define turf for different agencies. One of the complex things about the crypto space is how polarizing it is in Washington, and how strongly held the views are on opposing sides. We have had this rather spectacular collapse with UST stablecoin and Terra Labs.. there is a lot of concern for what that would do. The point of regulators and the publics-- stablecoins seem to be adding to these concerns about another regulatory backlash. How do you see these things playing out? What is the current market doing to this debate as its taking place?

RB: In my view, and personally, it validates what has been said and what I've been saying for the past couple years. We need to put guardrails around this space. I don't want to say these things should happen, in fact they should not happen. It was a terrible fall in the price and many people were hurt by this. This really underlies the reason why we need a regulatory structure around the space. I am sure there are many in this audience that would disagree, for sure, but I've said this often. In the US capital markets, derivatives markets and our other markets are the deepest and most liquid in the world because of our regulatory structure: it is fair, transparent, there is accountability for bad actors, and there's an understanding to Dawn's point about what you're getting into when you participate in these markets whether it's as a client or an intermediary or an exchange or anything else. I don't take an opinion often in my capacity about what may or may not emerge from a technology, that's not my job. My job is to enforce the law and make sure commodity markets are running well, that we don't have financial stability issues or resiliency in the market issues, but when you think about what happens with Terra and some of these price movements-- these are the exact issues that have been raised multiple times by myself and my colleagues that perhaps the impacts of the cryptosystem can have on traditional finance, and that's what we need to prevent.

MC: There is always a risk of over-regulation, and trying to encourage innovation in this space is very important. Are we at risk that we go too far as an over-reaction to these market events?

DS: We are always at risk. I think people sometimes view the regulators as this thinktank. Regulators are just humans, though. There's always this reaction to the human element in something like Terra happens, and I think at the CFTC though, because innovation is part of our mission we have helped promote--- some days we're very uncomfortable at the CFTC and those are the days when we need to step back and say what are our jobs? It's to protect customers, but also to encourage innovation and let people invest in a way that they choose to do. This is really hard. Investors are free to invest and to build wealth in the United States, and investors are free to make mistakes and that part makes regulators really uncomfortable because when you know people might and will make mistakes you want to help them to not do that, but regulators are not nannies. You have to let people fail when they want. That's the balance between innovation and protection; you can permit or prohibit and getting the right balance is really hard. Anyone who signs up to do this job... it's uncomfortable, it's not a glorious job.

MC: There's so much more to talk about, but in that short period we have left, I'd like to hear a quick take on what the future looks like. Where does it all go from here?

RB: I won't opine on the technology because that's not my job. I do think that having observed and been around this space in a regulatory capacity since 2017 and a policy capacity even before that, I'm really encouraged by what we saw yesterday with Senator Lummis and other senators... We're going to see more bills filed, I think, in congress in the next couple weeks or months and it's just postiive momentum for the technology, indsustry and the economy, and from my point of view the markets resilience and systemic risk standpoint there's unique coalitiions getting together on this issue which is rare in Washington where you have stakeholders in the industry wanting to be regulated, but for those of us who care about regulation from a customer protection standpoint and market resiliency standpoint and managing those risks and seeing this technology grow-- from a US perspective, we want to see the tech stay here and develop and evolve and strengthen and create jobs and growth. I use this word not lightly, but US supremacy in growth of technology that we have seen for decades.


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