Remarks of CFTC Commissioner Caroline D. Pham Before the Cato Institute, Staying Ahead of the Curve: Crypto Regulation and Competitiveness
New Regulatory Sandboxes: A Proposal for a CFTC Pilot Program
September 07, 2023
Good afternoon. I would like to begin by extending my thanks to the Cato Institute for inviting me to speak before such an esteemed group—both those presenting at, and attending, today’s conference. It is an honor to be speaking alongside and before some of the most prominent thought leaders in the world at Cato.
I’ll take a moment to say that my remarks are my own views as a Commissioner and do not necessarily represent the views of the Commodity Futures Trading Commission (CFTC or Commission), my fellow Commissioners, or the staff.
Staying ahead of the curve is what my prior career was about, and something I have continued to champion since being sworn in as a CFTC Commissioner in April 2022.
The World Waits for No One: It’s Time for a U.S. Regulatory Sandbox
During my international tour last year to kick off the relaunch of the CFTC’s Global Markets Advisory Committee, which I sponsor, I met with central banks, finance ministries, regulators, and other policymakers. We discussed approaches to technology and responsible innovation to support economic growth. And what I have learned is that in many other jurisdictions across the UK, Europe, Asia, and the Middle East, policymakers and regulators are unified in their approach to diversifying and growing their economy as a matter of industrial policy. I am impressed by the way that other countries encourage growth and progress—two guiding principles of my commissionership.
The United States is home to the world’s first trillion-dollar public company, borne out of Silicon Valley in 2018. And now, all five public companies with a market cap of over a trillion dollars are still U.S. tech companies. But I am concerned that we have taken our past progress for granted. A “wait and see” approach in the U.S. towards the potential opportunities of blockchain technology and digital assets falls short of the proactive measures needed in this rapidly evolving industry.
That is why I have consistently called for the CFTC to use our existing authority to provide regulatory clarity for digital assets to ensure that robust guardrails are in place. Right after I was sworn in, I published an op-ed together with SEC Commissioner Hester Peirce calling for public roundtables to examine the crypto crash and propose reforms. I was the first U.S. regulator to propose a comprehensive regulatory framework with my ten fundamentals for responsible digital asset markets. I proposed the CFTC’s first-ever Office of the Retail Advocate to give a voice to the retail public and focus on retail protection. I sponsored the creation of a Digital Asset Markets subcommittee of the CFTC’s GMAC to develop recommendations for industry standards and best practices, including taxonomy; pre-trade, execution, and post-trade requirements; and governance, risk and control frameworks.
Today, I will propose that the CFTC launch the first-ever U.S. pilot program for digital asset markets. Our principles-based framework is built for innovation in technology, new products, and market structure. In waiting and seeing, we’re missing opportunities to capitalize on all the benefits of the technology before us, while others take a more strategic and long-term view. The U.S. may soon find ourselves constantly playing catch-up, unable to effectively leverage this technology for economic growth.
Jurisdictions all around the world have embraced the drive to stay ahead of the curve and launched innovation facilitators, or “regulatory sandboxes”. In the U.S., the federal regulatory framework raises challenging legal issues—including the fact that the CFTC is an enforcement agency—for agencies like ours and the SEC to structure and design regulatory sandboxes. While U.S. federal agencies have created offices dedicated to FinTech, true regulatory sandboxes have been limited to the states.
However, as I will discuss today, the CFTC and SEC have in the past had success launching pilot programs. At their core, pilot programs provide a way to strategically introduce and refine new initiatives. When thoughtfully designed, they can help minimize risks and maximize the chances of a new idea succeeding. Like regulatory sandboxes, pilot programs can be an effective tool to meaningfully facilitate innovation.
It’s time to take action. A pilot program can create a safe framework for emerging technologies and market structures under our existing laws and regulations. To get there, I will begin by reflecting on the characteristics of past pilot programs, which have all played a role in shaping our markets. I will then recommend the CFTC help the U.S. stay ahead of the curve by commencing a pilot initiative for digital asset markets. It is my hope that a pilot to test, gather data, and develop a pragmatic approach to digital assets and tokenization can ensure we continue to uphold our mandate of fostering open, transparent, competitive, and financially sound markets.
Past Pilot Programs Safely Explored New Products and Evolving Market Structure
I’ll start by briefly touching on the key features of three past pilot programs before recommending an approach for the CFTC to take today.
First, in September, 1995, the CFTC launched a three-year pilot program to permit a new class of transactions to trade. The CFTC launched the pilot program with the goal of permitting these products greater flexibility in competing with non-U.S. exchange-traded products while maintaining customer protection, financial integrity, and other protections associated with trading in an exchange environment. At the time, exchanges sought to permit greater flexibility for exchanges to offer products to sophisticated traders.
After soliciting comment on the exchange petitions and proposed rules, the CFTC adopted final rules that would expire after three years, with the Commission committing to review the program and whether to make it permanent well before the end of the pilot period to provide market certainty.
The pilot program had four main components:
- Trading rules. The rules provided a framework of safeguards intended to set forth conditions for executing the transactions, including the process for submitting product terms and conditions for listing and Commission review.
- Reporting requirements. Exchanges had to provide the CFTC with open interest, pricing, and trader reports.
- Registration requirements. Introducing brokers and associated persons could be granted temporary licenses or registrations for the products subject to certain fitness requirements and providing identifying information.
- Risk disclosure requirements. Futures commission merchants had to disclose material information about the transactions to customers.
Second, in April 1998, the CFTC launched a three-year pilot program to permit the purchase and sale of agricultural trade options on certain commodities. At the time, the agricultural community wanted to use these products as a risk management tool, but they had been banned for over 60 years.
After a number of public meetings and receiving over 400 comments on proposed rules, the CFTC adopted interim final rules to permit the trading of these products. After the three-year trial, the CFTC would consider whether the rules should be made permanent.
This pilot program also had four main components, although slightly different:
- Registration. Agricultural trade option merchants and their associated persons were required to register. The interim final rules set forth application requirements, along with fitness standards as part of registration.
- Financial requirements. Applicants for registration needed to operate in commercial agricultural markets and have a minimum net worth. Financial statements were required to be provided, and grounds like having been convicted of theft, fraud, embezzlement, or similar wrongdoing disqualified applicants from registration.
- Conditions on the contracts. Among other conditions, all agricultural trade option contracts had to be in writing, and the merchant had to give the customer a signed copy of the written contract. The contract also had to state the amount in grade of the commodity where delivery should be made if the option is exercised.
- Disclosures and reporting. Before entering into an agricultural trade option, the merchant had to disclose to the customer information about the general risks of agricultural trade options, as well as information about the specific option contract, including its terms and cost.
Third, and finally, in June 2010, in response to the Flash Crash of May 6, 2010 a few weeks earlier, the SEC adopted rules on a pilot basis through December 2010 establishing circuit breakers to pause trading in certain individual stocks for exchanges and FINRA. After the Flash Crash, U.S. exchanges filed proposed rule changes providing for trading pauses in individual stocks when the price moved 10% or more in the preceding five minute period. The SEC was able to adopt the rules on an expedited basis on the grounds that they represented a useful first step that would improve the existing procedures for protecting investors and maintaining fair and orderly markets.
The SEC approached the circuit breaker program in three phases, initially intending that the markets would use the pilot period to make adjustments to the circuit breakers when needed based on their experience, and to expand the scope of securities subject to the circuit breakers when practicable. After the first phase, the exchanges added additional securities as expected. Eventually, the pilot program led to the SEC adopting its “limit up-limit down” mechanism, initially on a pilot basis again.
Overall, these pilot programs were designed to help regulators develop robust frameworks that address emerging trends and challenges effectively. The programs also fostered a collaborative environment for regulators and market participants to work collectively towards common goals.
A New CFTC Pilot Program to Ensure Responsible Innovation
Staying ahead of the curve requires being ready to look to the future and preparing to embrace change. Previous Commissions and staff that designed past pilot programs were also grappling with the same issues we face today. I am sure they recognized their responsibility to serve the public by embracing technological advancements, fostering responsible innovation, collaborating with stakeholders, continuously learning and adapting to changing market conditions, and making data-driven decisions.
As a regulator overseeing the largest financial markets in the world, we have a responsibility to proactively take on new challenges instead of passive observation. That’s why I’m recommending a time-limited CFTC pilot program to support the development of compliant digital asset markets and tokenization. In line with our previous pilot initiatives, I am optimistic that this approach will ensure the integrity of our markets and impartial access, foster liquidity and competition, address potential conflicts and risks, and prevent fraud, abusive practices, and manipulation.
As a first step, the CFTC should call for a roundtable to engage all stakeholders. We can leverage the work of the CFTC GMAC Digital Asset Markets Subcommittee to provide key insights on the design of a successful pilot program, as well as the work of other CFTC Advisory Committees. After that, the CFTC should propose and adopt rules establishing a pilot program for a specific period of time that incorporates many of the components drawn from past pilot programs, including: registration and eligibility requirements, financial resources and other conditions, risk management, products and contract terms, and other requirements including disclosures and reporting. I am confident that the public will suggest others as well. At the conclusion of the pilot program, the Commission should examine the data gathered from the pilot and consider whether there should be a permanent change to our rules.
This proposal shows us how the CFTC can safely explore innovation while maintaining appropriate protections for our markets. My proposal shares the undeniable goal of helping keep the U.S. ahead of the curve—a goal I am sure we all share. As I have said before, my approach to any challenge is to get all the information, learn as much as possible, and then find pragmatic solutions, with an eye toward making policy that is informed and practical. I believe a time-limited pilot program is the perfect next step consistent with that approach.
Thank you again to Cato for having me, and I look forward to hearing from the public on my proposal.
 CFTC Release No. 8703-23, “Commissioner Pham Announces Proposed Work Program for the CFTC Global Markets Advisory Committee and Seeks Input by May 30” (May 15, 2023), https://www.cftc.gov/PressRoom/PressReleases/8703-23.
 Thomas Heath, “Apple is the first $1 trillion company in history” (Aug. 2, 2018), Washington Post, https://www.washingtonpost.com/business/economy/apple-is-the-first-1-trillion-company-in-history/2018/08/02/ea3e7a02-9599-11e8-a679-b09212fb69c2_story.html.
 Caroline D. Pham and Hester M. Peirce, “Making progress on decentralized regulation—It’s time to talk about crypto together” (May 26, 2022), The Hill, https://thehill.com/opinion/congress-blog/3503277-making-progress-on-decentralized-regulation-its-time-to-talk-about-crypto-together/.
 Keynote Address by Commissioner Caroline D. Pham, 18th Nasdaq Technology of the Future Conference—Reimagining Tomorrow’s Markets, “Regulation of the Future: Building Responsible Digital Asset Markets” (June 28, 2022), U.S. Commodity Futures Trading Commission, https://www.cftc.gov/PressRoom/SpeechesTestimony/opapham3.
 Keynote Address by Commissioner Caroline D. Pham at CordaCon 2022, “A Voice for the People: A Proposal for A New Office of the Retail Advocate” (Sept. 27, 2022), U.S. Commodity Futures Trading Commission, https://www.cftc.gov/PressRoom/SpeechesTestimony/opapham5.
 The world’s first FinTech regulatory sandbox is credited to the UK Financial Conduct Authority in 2016, which has been viewed as largely successful. Deloitte EMEA Centre for Regulatory Strategy, “A Journey Through the FCA Regulatory Sandbox,” https://www2.deloitte.com/content/dam/Deloitte/uk/Documents/financial-services/deloitte-uk-fca-regulatory-sandbox-project-innovate-finance-journey.pdf. The success of the UK scheme has been replicated across the globe with over 70 regulatory sandboxes in over 50 jurisdictions being launched in recent years. The World Bank, Key Data from Regulatory Sandboxes Across the Globe (Nov. 1, 2020), https://www.worldbank.org/en/topic/fintech/brief/key-data-from-regulatory-sandboxes-across-the-globe. It has been noted that in the U.S. the adoption of regulatory sandboxes has been slow and challenging. While agencies including the CFTC have established FinTech-focused offices, questions have been raised over whether sandboxes are feasible. Marco Frattini et. al, “EU and U.S. Regulatory Sandboxes: Groundbreaking Tools for Fostering Innovation and Shaping Applicable Regulations,” JD Supra (May 2, 2023), https://www.jdsupra.com/legalnews/eu-and-u-s-regulatory-sandboxes-2759128/#:~:text=Background%3A%20A%20regulatory%20sandbox%20can,regulator%20for%20a%20limited%20timeframe.
 Dan Quan, “A Few Thoughts on Regulatory Sandboxes,” Stanford Center on Philanthropy and Civil Society (2019), https://pacscenter.stanford.edu/a-few-thoughts-on-regulatory-sandboxes/#:~:text=Hence%20regulators%20should%20spend%20the,that%20benefit%20the%20entire%20ecosystem. Professor Quan, Adjunct Scholar at the Cato Institute’s Center for Monetary and Financial Alternatives, has written on how to design regulatory sandboxes for success, suggesting principles that could also apply to pilot programs. This includes starting with a dedicated outreach strategy to understand the market, promoting innovation-friendly policies, and focusing on removing obstacles to launching new products that might not only be fully compliant but also beneficial to the markets. See id.
 CFTC Press Release #3865-95, “CFTC Approves Final Rule to Establish a Three-Year Pilot Program to Test Various Trading Innovations” (Sept. 21, 1995), https://www.cftc.gov/sites/default/files/opa/press95/oparulemk.htm.
 Section 4(c) Contract Market Transactions, 60 Fed. Reg. 51,323 (Oct. 2, 1995).
 Id. at 51,324.
 Id. at 51,327.
 Id. at 51,334.
 Id. at 51,339.
 Id. at 51,340.
 Id. at 51,339.
 CFTC Press Release #4135-98, “[CFTC] Lifts Ban on Agricultural Trade Options; Announces Pilot Program” (Apr. 9, 1998), https://www.cftc.gov/sites/default/files/opa/press98/opa4135-98.htm.
 Trade Options on the Enumerated Agricultural Commodities, 63 Fed. Reg. 18,821, 18,823 (Apr. 16, 1998).
 Id. at 18,825.
 Id. at 18,826.
 Id. at 18,828.
 Press Release 2010-98, “SEC Approves New Stock-by-Stock Circuit Breaker Rules” (June 10, 2010), https://www.sec.gov/news/press/2010/2010-98.htm#:~:text=Under%20the%20rules%2C%20trading%20in,over%20the%20preceding%20five%20minutes. The SEC has dozens of examples of pilot programs to draw from, but the circuit breakers in response to the Flash Crash demonstrate how an agency can nimbly adjust, expand, or narrow a pilot working alongside industry participants over time.
 SEC Release No. 34-62252, “Order Granting Accelerated Approval to Proposed Rule Changes Relating to Trading Pauses Due to Extraordinary Market Volatility” (June 10, 2010), https://www.sec.gov/files/rules/sro/bats/2010/34-62252.pdf.
 Id. at 12.
 SEC Release No. 34-67091, “Order Approving on a Pilot Basis, the National Market System Plan to Address Extraordinary Market Volatility [by U.S. Exchanges]” (May 31, 2012), at 5.
 See id.
 See Statement of Commissioner Caroline D. Pham Regarding NFA Rule on Spot Digital Asset Commodity Activities (Mar. 31, 2023), U.S. Commodity Futures Trading Commission, https://www.cftc.gov/PressRoom/SpeechesTestimony/phamstatement033123.
 Keynote Address by Commissioner Caroline D. Pham, 98th Annual Convention of the American Cotton Shippers Association, “We’re Finally on the Job—Now Let’s Get to Work” (June 22, 2022), U.S. Commodity Futures Trading Commission, https://www.cftc.gov/PressRoom/SpeechesTestimony/opapham2.