Good evening.  It is my great pleasure and honor to be here at EUROFI Prague.  I wish to thank David, Didier, and Marc for organizing this important event.  Eurofi was launched more than 20 years ago during a time of great change and consolidation—in the middle of the launch of the common currency—designed for more efficient payments and price transparency, bringing its own promises and challenges.  Now, perhaps it’s no surprise that many are exploring the promises and challenges of virtual currency.

I also wish to thank the Czech Presidency of the European Council for hosting us in Prague. It is an opportunity for central bankers, finance ministers, regulators, and other policymakers to come together with key leaders to discuss the world’s most pressing issues and potential solutions.  It is in times of great challenge that it is more important than ever to remember that connection to others is one of the most defining characteristics of humanity.  Throughout all my exchanges with policymakers, both domestically and in Europe and Asia, I am struck more by the commonalities we share, and not so much by any differences.  I’m so pleased to be here, to reconnect with many, and to make new connections with you all.

It is fitting that we are looking into the present and future of banking and markets, including the further digitalization of finance.  We should remember our past as we imagine the future, particularly as we continue what’s been called a “150-year revolution” of financial technology.

Last year was the 100^th anniversary of the premiere of Karel Čapek’s play here in Prague that first used the word “robot.”  Today, we see much in financial technology that would have seemed science fiction not too long ago.

As you may know, I used to work in regulatory strategy. Now that I have returned to the public sector, it seems only appropriate that I share some thoughts on a regulator’s strategy for what may well be the next chapter in the digitalization of finance—science fiction come to life, the metaverse.

In approaching this topic, it is my hope to raise some key questions—what is the metaverse?  Why do we care?  What should we do as policymakers? that will spark ongoing dialogues and provide one approach to addressing the opportunities and risks to not only the financial system, but perhaps even society and community itself.

Before I proceed, I’ll say now that these are my views and do not reflect those of the CFTC or any other Commissioner.

The metaverse is here now

The metaverse is here now.  Corporations, venture capital, and private equity have already invested more than $120 billion into the metaverse space in the first five months of 2022.

I would like to share some statistics.  A recent McKinsey & Company report found that some 95 percent of business leaders expect the metaverse to have a positive impact on their industry within five to ten years, and 61 percent expect it to moderately change the way their industry operates.  The report also found that the industries most likely to be impacted by the metaverse include consumer and retail, media and telecommunications, and healthcare—and those industries are also among those already undertaking metaverse initiatives.  These are major mainstream consumer brands, beyond large technology companies like Meta (formerly Facebook), Microsoft, Apple, and Alphabet (Google).

In the near term, the metaverse may generate up to $5 trillion in impact by 2030—if not more.  High potential consumer use cases include e-commerce, and high potential enterprise use cases include banking, discrete manufacturing, professional services, retail, telecommunications, media, and process manufacturing.  The examples beyond the financial sector show the value proposition in the real economy.  Major corporations and others have invested significantly, and I note that one of the top corporate capabilities they’re focused on to deliver these metaverse strategies is legal, risk, and compliance.  This isn’t all the Wild West.

I believe that studies like these show that the metaverse is far more than speculation on crypto assets—it is “the real business of the virtual world.”  Some describe the metaverse as the next iteration of the internet, something we are immersed in, a three-dimensional version.  I also find compelling the vision of the metaverse offered by some that focuses on the ability to have a unique identity coupled with an economy.

The metaverse may very well be our next life: a life where the lines between our physical and digital lives are increasingly blurred, where we seamlessly switch or exist in layered experiences simultaneously, which ultimately creates a new dimension to society and community.  It could even materialize a “network state” of the minds, not the lands.

We’ve long seen conceptions of the metaverse in the realm of science fiction.  William Gibson’s Neuromancer described people connected to what he called cyberspace almost 40 years ago, and Neal Stephenson’s Snow Crash imagined the metaverse a few years later.  And more recently, the movie Ready Player One presented an immersive virtual reality world called the Oasis.

In some ways, online gaming is a preview, a “proto-metaverse,” of what’s in store.  Online video games provide experiences of digital, interactive worlds involving identities and economies.  I expect some parents here agree: not only is the metaverse here, but they wish their kids would spend less time there.  And gaming is already big business.  I was surprised to learn that gaming is larger than other subsectors of the entertainment industry like movies and music, with more than three billion users globally and a total value of more than $200 billion.

The metaverse or not

I would distinguish the idea of the metaverse from Web3.  In my view, what’s been considered Web3—a decentralized internet of ownership where users can own, monetize, and utilize their data to their own benefit, enabled by blockchain, digital assets, and smart contracts—isn’t a necessary condition or required for the metaverse.  But Web3 could unlock more of the open metaverse’s potential.  That is why I believe we must be forward-looking and deliberate in addressing the policy issues of Web3 and digital assets in order to protect users but not inadvertently derail our next life.  The great debate over crypto may be only a waypoint on the journey to the metaverse.

As a side note, it’s also my view that augmented reality (AR) or Virtual Reality (VR) is not required to experience the metaverse.  When I was in Seoul earlier this year for Korea Blockchain Week, I saw the metaverse with my own eyes on a regular screen.  AR/VR is an enhancement right now.

What happens when life goes digital?

Look further into the future and ask what happens when more of our lives, financial and otherwise, become digitized in the metaverse.  The top five metaverse activities that consumers are excited about are social, entertainment, gaming, travel, and shopping.  The top five enterprise use cases that companies are already implementing in the metaverse are marketing, employee learning and development, business meetings, events or conferences, and product design (digital twinning).

The public sector is also exploring use cases in the metaverse.  Dubai’s Virtual Assets Regulatory Authority (VARA) is the first regulator in the metaverse, establishing a headquarters in The Sandbox platform.  Seoul is the first city government that is set to join the metaverse with a virtual Seoul City Hall, plaza, and civil-service center and announced a five-year “Metaverse Seoul Basic Plan” in order to provide “civic freedom, participation, engagement, and communication,” and South Korea’s Ministry of Science and Information and Communication Technology recently released a consultation on eight ethical principles for the metaverse ecosystem: authenticity, autonomy, reciprocity, respect for privacy, fairness, data protection, inclusiveness, and accountability.

In financial services, use cases include marketing, infrastructure, and new products and services.  Potential opportunities in a future metaverse that embodies a next life could include multicurrency cash management for native metaverse wallet owners; servicing, like virtual real-estate mortgage origination and warehousing; funds and investing services for metaverse projects; enhanced customer engagement like unique loyalty experiences; but also potential financialization of everything through the use of digital assets in the metaverse, which may present unique challenges for financial regulators.

Metanomics and utility

One aspect of the metaverse will be facilitating use and engagement through digital assets sometimes called utility tokens.  These have sometimes been defined as digital tokens that provide digital access to a good or service, are available on blockchain, and that are valid within a particular economy.  These are things, not financial instruments.  Put differently, just because you can financialize something doesn’t mean that it is always financial in nature.  Real economy examples of true utility tokens—not fraudulent ICOs—show that they can be far more than just speculative financial instruments.

If utility tokens are the key to accessing much of the utility of our next life in the metaverse, we must be open minded and embrace possibilities in ways that do not stifle innovation, while still protecting against misconduct and abuse.

Gaming once again provides a way to understand these tokens.  As a kid, I remember going to the arcade at the mall and buying tokens to play the games.  I wasn’t an investor in the arcade—I was using a fungible good the arcade sold to access the games.  Today’s games have a lot more features.  And you can spend money for more things than just playing the game or extra lives.  But the essence is the same.

Another example of what are essentially utility tokens that we have today are transit rewards points.  Those of us who traveled to Prague by air may have been members of a frequent flyer program, building points that may be used towards future flights or services.  Perhaps more befitting of Web3, an airline recently sold blockchain-based tokens for use in purchasing charter flights and related services.[1]  These tokens did not offer any rights to the profits of the company, but rather only a more efficient and faster way to obtain the services.

In the EU’s MiCA Regulation, and the regulatory frameworks in Switzerland, Liechtenstein, Dubai, and others, utility tokens or usage tokens are distinct from other categories.  For our part, the CFTC’s regulatory framework is relatively asset- and technology-neutral.  Our focus on principles-based regulation, customer protections, market integrity, risk management, price discovery, and transparency has worked well for our markets for decades in part because it is flexible enough to allow for innovation and change while ensuring strong protections are in place.

Metaverse and policy

There are key areas that need to be further developed and matured to achieve the full metaverse and its potential for engagement, community building, self-expression, and commerce.  They include technology; commercial infrastructure; privacy and identity; workforce of the future; and regulation, tax, accounting, and social infrastructure.

As these areas are developed, one question in particular stands out: how do regulators address the development of solutions and services to support virtual worlds that are globally accessible, but may be required to adhere to local jurisdictional requirements and rules in commerce and payments?  Luckily, this question is not a new one, as it is a further extension of how regulators have approached globalization and past technological innovations that enable cross-border activity.

Just as regulators have had to tackle the digitalization of finance, so too must we look ahead to the future and the increasing digitalization of life.  In many ways, much of our life involves transactions.  Some say that the foundational layers of the metaverse—the “enablers”—are security, privacy, and governance; identity; and payments and monetization.  These are issues that are very familiar to financial regulators, financial institutions, and new entrants like fintechs.  You could say that money is life.

Some of the other critical issues for policymakers to consider include open access to the metaverse; competition and promoting innovation; intellectual property rights; commerce, monetization and distribution models between stakeholders; promoting diversity, equity, and inclusion; securing user safety and awareness; and ensuring data privacy.

The metaverse also has broader societal implications.  Relevant stakeholders will need to define a road map toward a metaverse that is ethical, safe, and inclusive.  This likely will include rules relating to data privacy, security, ethics and regulatory compliance, physical health and safety, and equity and fairness.

Because metaverse development is still in its early stages, I believe a principles-based approach to emerging policy issues appropriately reflects the need to anticipate and adapt to issues and risks quickly.  I also believe it is imperative for regulators to proactively engage with the private sector, and ensure the responsible development of products and services that have embedded protections.

A regulator’s strategy for the metaverse

As I have previously said, I believe that the way to get things done is to get all the information, learn as much as possible, and then find pragmatic solutions.  Just as business leaders need to identify a strategy for the metaverse, I believe that it is incumbent upon regulators to do the same.  I believe that we must learn more about the metaverse, assess the policy issues, create expertise and resource, connect with other policymakers, and establish a regulatory approach that is fit-for-purpose with each of our singular legal structures and authorities.  Throughout all this, we must ensure global cooperation and coordination, because the metaverse is truly a world without borders.

The internet’s emergence led to the profusion of social media, mobile connectivity, and cloud computing.  The emergence of the digitalization of finance has led to what a few decades ago would have been the realm of science fiction: using pocket-sized supercomputers to make and receive near-instant payments across the world.  And today’s technologies may put us on the verge of a metaverse of real-time, immersive, massively multi-person content, experiences, and connections, potentially with a financial transaction layer powered by Web3.  We could be moving from crypto and blockchain as a wrapper on value to a wrapper on reality.

If the metaverse is too big for companies to ignore, then it is too big for regulators to ignore as well.  If the metaverse is, at the very least, another iteration of our current life, all current regulatory issues will iterate there as well.  And this digital layer imposed on our physical layer may bring new issues as well.

And if the metaverse is truly our next life, we can’t avoid it.  It’s better to face it head on and build in now the protections we will need.  But we can’t be so shortsighted that we foreclose the future by regulating the technology out of existence.

Karel Čapek’s play coined the term robot but also anticipated key concerns of systemic risk posed by technology.  There’s no guarantee that new technologies such as AI or the metaverse will follow Isaac Asimov’s 1942 Three Laws of Robotics by default, especially the Zeroth Law: A robot may not harm humanity, or, by inaction, allow humanity to come to harm.  For that, it will take careful observation, foresight, and nimbleness from policymakers and regulators.

***

References

Sirio Aramonte, Andreas Schrimpf, and Hyun Song Shin, “Non-bank financial intermediaries and financial stability,” Bank for International Settlements Working Papers No. 972 (Oct. 2021, rev. Jan. 2022).

Isaac Asimov, I, Robot (1950).

Board of Governors of the Federal Reserve, SR-26 / CA2-6: Engagement in Crypto-Asset-Related Activities by Federal Reserve-Supervised Banking Organizations (Aug. 16, 2022).

Karel Čapek, R. U. R. (1920).

Sir Jon Cunliffe, Deputy Governor for Financial Stability of the Bank of England, speech at Eden Hall, the British High Commissioner’s Residence in Singapore, “Some lessons from the crypto winter” (July 12, 2022).

Dubai Virtual Assets Regulatory Authority, see www.vara.ae.

Erik Feyen, Jon Frost, Leonardo Gambacorta, Harish Natarajan, and Matthew Saal, “Fintech and the digital transformation of financial services: implications for market structure and public policy,” Bank for International Settlements Working Paper No. 117 (July 2021).

Financial Stability Board, “Assessment of Risks to Financial Stability from Crypto-assets” (Feb. 16, 2022).

Leonardo Gambacorta, Fahad Khalil, and Bruno M. Parigi, “Big Tech vs Banks,” Bank for International Settlements Working Paper No. 1037 (Aug. 2022).

Ronit Ghose, Nissan Surendran, Sophia Bantanidis, Kaiwan Master, Ronak S. Shah, and Puneet Singhvi, “Metaverse and Money: Decrypting the Future,” Citi (Mar. 2022).

Ronit Ghose, Judy Zhang, Kaiwan Master, Ronak S. Shah, and Yafei Tian, “Future of Money: Crypto, CBDCs, and 21st Century Cash,” Citi (April 2021).

William Gibson, Neuromancer (1984).

Chair of the Basel Committee on Banking Supervision and Governor of the Bank of Spain Pablo Hernández de Cos, Keynote speech at the 22nd Euro Finance Week, Frankfurt, “Financial technology: the 150-year revolution” (Nov. 19, 2019).

Chair of the Basel Committee on Banking Supervision and Governor of the Bank of Spain Pablo Hernández de Cos, Keynote speech at the Eurofi High-Level Seminar 2022, “Old risks, new challenges, same objective: the work programme of the Basel Committee in 2022” (Feb. 25, 2022).

Howell E. Jackson, Timothy G. Massad, and Dan Awrey, “How We Can Regulate Stablecoins Now—Without Congressional Action,” The Brookings Institution (Aug. 2022).

Managing Director of the Monetary Authority of Singapore Ravi Menon, Opening address at the Green Shoots Seminar, “Yes to Digital Asset Innovation, No to Cryptocurrency Speculation” (Aug. 29, 2022).

Sharmin Mossovar-Rahmani, Matheus Dibo, Jakob Duda, Oussama Farris, Shahz Khatri, Shep Moore-Berg, and Yousra Zerouali, “Digital Assets: Beauty Is Not in the Eye of the Beholder,” Goldman Sachs (June 2021).

Christine Moy and Adit Gadgil, “Opportunities in the Metaverse,” J.P. Morgan (Jan. 2022).

McKinsey & Company, “Value Creation in the Metaverse: the Real Business of the Virtual World” (June 2022).

Commissioner Caroline D. Pham, Commodity Futures Trading Commission, Keynote address at the 18^th Nasdaq Technology of the Future Conference—Reimagining Tomorrow’s Markets, “Regulation of the Future: Building Responsible Digital Asset Markets” (June 28, 2022).

Press release, South Korea Ministry of Science and Information and Communication Technology, “Ministry of Science and ICT held a discussion forum to discuss ethical principles for the expanding virtual world,” (Aug. 26, 2022).

Fernando Restoy, Chair, Financial Stability Institute, Bank for International Settlements, Presentation for EBA Board of Supervisors’ Away Day, “Big tech regulation: in search of a new framework” (July 12, 2022).

Release, Seoul Metropolitan Government, “Seoul, First Local Government to Start New Concept Public Service with ‘Metaverse Platform’” (Aug. 8, 2021).

Balaji Srinivasan, The Network State (2022).

Neal Stephenson, Snow Crash (1992).

United Arab Emirates, Dubai Metaverse Strategy (Aug. 2022), https://u.ae/en/about-the-uae/strategies-initiatives-and-awards/local-governments-strategies-and-plans/dubai-metaverse-strategy.

[1] Response of Division of Corporation Finance, U.S Securities and Exchange Commission, In re Turnkey Jet, Inc. (April 3, 2019).

Yesterday, the Commodity Futures Trading Commission (CFTC) entered two orders relating to the mismarking of swap positions, one for fraudulent conduct and another for supervision failures that allowed for mismarking to occur.  Companies around the country and across the globe use swaps, which comprise a global market with a notional value in the hundreds of trillions of dollars, to manage risk.  As evidenced by the events that precipitated the onset of the 2008 financial crisis, however, swaps—an unregulated sector of financial markets at that time—concentrated risk, obscured risk management failures, and contributed to one of the most pernicious financial market crashes in recent history.  The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) introduced several key reforms; among these monumental regulatory initiatives, the Dodd Frank Act directed the CFTC to exercise its oversight authority in the markets for certain swaps.  The CFTC’s implementation of these critical reforms has increased transparency in swaps markets through mandatory reporting of swaps and governance reforms for market participants such as swaps dealers.

Section 4s of the Commodity Exchange Act (CEA) contains the key swap provisions added by the Dodd-Frank Act.[1]  CEA Section 4s(f) imposes reporting and recordkeeping requirements on registered swap dealers and major swap participants, including a requirement to keep books and records as prescribed by the CFTC.[2]  These requirements were implemented by the CFTC in Subpart F of Part 23 of the CFTC’s Regulations.[3]  The Dodd-Frank Act also added CEA Section 21, which established a new category of registrant—swap data repositories—to collect and disseminate information about the swaps being entered into, in order to avoid the opaque accumulation of risk that characterized the markets leading up to the financial crisis.[4]  Increased transparency leads to lower costs, greater liquidity, and lower risk for the swaps market.  However, these benefits are not achieved if market participants provide inaccurate or misleading information about the swaps they are entering into—which is why it is crucial for the CFTC to enforce compliance with the reporting and recordkeeping requirements in the CEA and CFTC Regulations.

Other aspects of Dodd-Frank Act reforms aim to improve the governance of swap dealers to ensure the greater safety and soundness of the swaps market.  CEA Section 4s(h)(1)(B) requires swap dealers to conform with business conduct standards relating to the diligent supervision of the business of the swap dealer, as set forth in Regulation 23.602.[5]  Pursuant to this rule and other provisions of the business conduct standards, swap dealers must establish risk management programs and designate senior personnel to oversee them.  In this way, swap dealers become responsible for ensuring compliance with the CFTC’s Regulations so that the Dodd-Frank Act reforms may achieve intended prudential and regulatory goals.  The CFTC’s enforcement actions in these matters and others parallel these aims and seek to ensure that swap dealers are, in fact, implementing appropriate and mandated risk management programs effectively.  Those who fail to meet their supervisory responsibilities should anticipate inquiries, investigations, and the possibility of enforcement actions.

The orders entered yesterday provide valuable examples of the CFTC carrying out its mission to appropriately pursue failures to comply with reporting and recordkeeping requirements, on the one hand, and supervision requirements, on the other.  The first order finds that, from approximately January 2015 to April 2018, Blaise Brochard (Brochard), a former managing director on the New York-based interest rate derivatives (IRD) desk at a global bank (Bank), mismarked the U.S. dollar (USD) IRD positions at the Bank in an attempt to inflate the profits and disguise the losses in the IRD desk’s trading book.  Brochard accomplished this scheme by submitting false or misleading entries in the Bank’s internal recordkeeping and accounting system relating to marking the of the Bank’s end-of-day USD LIBOR forward curve (Closing Curve).  Brochard’s markings should have reflected observable midmarket prices, yet Brochard improperly aligned the markings to benefit the IRD desk’s risk positions.  Brochard evaded detection by generally staying inside the internal control limits set by the Bank and by using complex spreadsheets to determine the Closing Curve, which only he could understand.  As a result, Brochard submitted false or misleading marks almost every day for three years and overstated the profit and loss (P&L) calculations of the IRD desk by approximately $25 million at its peak.  These types of violations can directly affect the integrity of the swaps data reported to the public and, if widespread, could undermine the intent of making such data transparent.

The second order finds that Natixis, a global bank and provisionally registered swap dealer headquartered in Paris, France, failed to diligently supervise the activities of two of its derivatives trading desks based in the U.S. from approximately January 2015 to November 2019.  During that time, traders on these desks separately engaged in misconduct by mismarking their swap positions to either inflate profits and minimize losses or, for one of the desks, to “smooth” out its P&L.  As a result of the misconduct, Natixis’s books and records were inaccurate in several respects, and Natixis conveyed inaccurate swap valuation data and daily marks to a swap data repository (SDR) and certain swap counterparties, respectively, on numerous occasions.  While Natixis maintained certain controls, those controls were insufficient to detect the various traders’ misconduct, which continued undetected for years.  In addition to the negative impact resulting from the reporting of inaccurate data, the failure of Natixis’s supervisory system created independent risk to the swaps markets that cannot go unaddressed.

As a sponsor of the Market Risk Advisory Committee (MRAC), I am deeply committed to ensuring that the CFTC remains focused on systemic risks that threaten the stability of the derivatives markets.  We must seek to continuously improve market integrity and mitigate risk.  Consistent with this commitment, the MRAC, through the work of its Interest Rate Benchmark Reform Subcommittee, has worked tirelessly to transition away from reliance on LIBOR and other IBORs.[6]  In addition, the CFTC recently issued a rule to protect financial stability in this global transition effort.  These matters, however, reinforce ongoing concerns over the internal and external reporting of rigged data and further highlight the importance of benchmark reform initiatives as well as conducting effective supervision and instilling robust compliance systems to identify these types of fraud.  Institutions must be diligent in their efforts to prevent such data rigging misconduct.

Here, I would like to note that the respondent in each of these matters received the benefit of a reduced penalty for substantial cooperation with the Division of Enforcement’s investigations, significantly conserving time and resources.  Cooperation by subjects of investigation is not only beneficial to the agency, but also to taxpayers and at times even the reliability and stability of our markets.

I acknowledge and appreciate the cooperation and assistance of the France’s Autorité des marchés financiers and the National Futures Association in these matters.  I applaud the diligent work of our Enforcement team, including Trevor Kokal, John Buffington, David Oakland, John C. Murphy, Patryk J. Chudy, Lenel Hickson, Jr., and Manal M. Sultan, for their efforts in this matter, as well as Pamela Geraghty from the Market Participants Division and Owen Kopon of the Division of Market Oversight for their assistance.

[1] 7 U.S.C. § 6s.

[2] 7 U.S.C. § 6s(f).

[3] 17 C.F.R. pt. 23, subpt. F.

[4] 7 U.S.C. § 24a.

[5] 7 U.S.C. § 6s(h)(1)(B); 17 C.F.R. § 23.602.

[6] See Clearing Requirement Determination Under Section 2(h) of the Commodity Exchange Act for Interest Rate Swaps To Account for the Transition From LIBOR and Other IBORs to Alternative Reference Rates, 87 FR 52182, (Aug. 24, 2022).

I respectfully dissent from the Commission’s decision pursuant to CFTC Rule 40.11 to require a review and impose a stay of up to 90 days on KalshiEX LLC’s (Kalshi) Congressional control political event contracts, because Rule 40.11 does not apply to the contracts and because the appropriate process is to review the contracts under Rule 40.3.

I would like to first thank staff in the Division of Market Oversight for their hard work and diligence on this matter.  The CFTC is able to effectively oversee our markets due to the experience and expertise of our staff, and they are to be commended for their dedication and faithful service.

1. BACKGROUND

1. Kalshi voluntarily submitted political event contracts for Commission approval pursuant to CFTC Rule 40.3.

Kalshi, a CFTC-registered Designated Contract Market (DCM), voluntarily submitted[1] the political event contracts for approval by the Commission pursuant to CFTC Rule 40.3[2] on July 20, 2022, after engaging in approximately 36 meetings with the Commission and staff over nearly a year (since late 2021), and numerous meetings with members of Congress.

Kalshi states that the political event contracts are permitted under the Commodity Exchange Act (CEA) and CFTC rules because, among other things: 1) Section 5c(c)(5)(C) and Rule 40.11 do not apply to the contracts because the underlying event of political control of Congress is neither gaming nor illegal under Federal or State law; 2) the contracts can be used to hedge predictable financial, economic, and commercial consequences; 3) the contracts would not negatively affect election integrity or the perception of election integrity; and 4) similar contracts can already be accessed by U.S. persons on other markets that are not registered or otherwise regulated by the Commission.

2. DISCUSSION

1. CEA section 5c(c)(5)(C) and CFTC Rule 40.11 apply only to certain event contracts based upon specifically enumerated activities.

Section 5c(c)(5)(C) provides that certain event contracts may be prohibited from being listed or made available for clearing or trading if the Commission determines such event contracts to be “contrary to the public interest” because they “involve” certain enumerated activities: an “(I) activity that is unlawful under any Federal or State law; (II) terrorism; (III) assassination; (IV) war; (V) gaming; or (VI) other similar activity determined by the Commission, by rule or regulation, to be contrary to the public interest.”[3]

The Commission exercised its discretion under Section 5c(c)(5)(C) (i.e., “may determine”) to promulgate its implementing Rule 40.11.[4] Rule 40.11(a) sets forth a prohibition on the trading and clearing of any event contract[5] that “involves, relates to, or references” (1) “terrorism, assassination, war, gaming, or an activity that is unlawful under any State or Federal law”[6]; or (2) “an activity that is similar to an activity enumerated in 40.11(a)(1) of this part, and that the Commission determines, by rule or regulation, to be contrary to the public interest” (emphasis added).[7]  Rule 40.11(b) is reserved.[8]

Rule 40.11(c) provides that the Commission may require a 90-day review if the event contract “may involve, relate to, or reference an activity enumerated in 40.11(a)(1) or 40.11(a)(2).”[9]  Rule 40.11(c)(1) requires that the listing or trading of the event contract be suspended (stayed) during the 90-day review period.[10]  Rule 40.11(c)(2) requires that the Commission issue an order approving or disapproving the contract at the end of the 90-day review period (or such other extended time period as agreed to by the registered entity (for example, a DCM)).

In promulgating Rule 40.11(a)(1) pursuant to Section 5c(c)(5)(C), the Commission determined that an event contract that “involves, relates to, or references” terrorism, assassination, war, gaming, or illegal activity is prohibited because it is contrary to the public interest.[11]  There is no further public interest test in Rule 40.11(a)(1); per the operation of the statute, the Commission must have already made its determination that the event contract is contrary to the public interest in order to prohibit its being listed for trading or accepted for clearing.[12]  Therefore, the Commission has no discretion to infer an additional case-by-case public interest test[13] under Rule 40.11(a)(1) because the plain meaning of both the statutory text and the rule text is clear and unambiguous.  An event contract is only prohibited under Rule 40.11(a)(1) if it is based upon the underlying activity of terrorism, assassination, war, or gaming, or an activity that is unlawful under any State or Federal law.[14]

Further, Rule 40.11(a)(2) prohibits an event contract that “involves, relates to, or references an activity that is similar to an activity enumerated in 40.11(a)(1),” only if the Commission has already promulgated a rule or regulation to determine that such activity is contrary to the public interest.[15]  Indeed, the preamble to the final rulemaking for Rule 40.11 explicitly states, “[The Commission] has determined not to propose such regulations at this time.”[16]  Therefore, Rule 40.11(a)(2) is not operative because the Commission has never satisfied the predicate condition of promulgating a rule or regulation in order to determine an activity that is similar to an enumerated activity is contrary to the public interest.[17]  Further, the rule text is clear on its face that the public interest test in Rule 40.11(a)(2) can only be applied through a rulemaking, and can only be applied to the underlying activity that is similar to an enumerated activity, as provided by Section 5c(c)(5)(C)(VI).[18]

2. The political event contracts are not based on any enumerated activities under Rule 40.11(a)(1), and the contracts are not subject to Rule 40.11(a)(2) because it is not operative.

Both Section 5c(c)(5)(C) and Rule 40.11 set forth language that refers to contracts that are based upon an event that involves an enumerated activity.[19]  And in the preamble to the final rulemaking for Rule 40.11, the Commission describes the rule as applicable to “contracts based upon the [enumerated activities] . . . ” (emphasis added).[20]  The preamble shows that whether an event contract is prohibited by Rule 40.11 depends on the underlying activity that the contract is based upon—the underlying activity that the contract “involves, relates to, or references.”[21]  With respect to the political event contracts here, the underlying activity is political control.

The Commission must apply the same Congressional intent to each of the enumerated activities, including an “activity that is unlawful under any Federal or State law” and “gaming.”  Otherwise, Section 5c(c)(5)(C)(i) would be internally inconsistent and in conflict with “‘traditional tools’ of statutory construction.”[22]

Accordingly, because “political control” is neither terrorism, assassination, war, gaming, nor unlawful under any Federal or State law, Rule 40.11(a)(1) does not apply to the political event contracts.  And, as discussed in II.A., Rule 40.11(a)(2) is not operative until the Commission promulgates a rule or regulation to determine that an activity that is “similar to” an enumerated activity is contrary to the public interest,[23] therefore, Rule 40.11(a)(2) does not apply to the political event contracts.

3. The Commission must apply principles of fair competition and fair treatment to similar contract markets.

We must apply our rules fairly. Congress has mandated that the CFTC promote responsible innovation and fair competition.[24]  The Commission is already allowing an unregistered event contract market, PredictIt, to continue to operate its political control markets through the November 2022 election cycle and until Feb. 15, 2023.[25]  But the Commission has not taken any action on Kalshi’s contracts, even though Kalshi submitted their request for voluntary approval over a month ago, and have been discussing it with the CFTC for almost a year.

In the interest of fair competition and fair treatment, Kalshi, a CFTC registered entity, should be allowed to operate their political control markets as well.  Although the Commission’s notification letter acknowledges that this issue is “time-sensitive” and that the Commission “will endeavor” to make a decision on the political event contracts by October 28, 2022, the Commission does not actually have to stick to that date.

And even if the Commission does make a decision by October 28 (and the decision is to approve—not deny—the contracts), Kalshi would only be able to realistically operate its political control markets for a couple of days before the November midterm elections.

The outcome is the same: the Commission’s action to impose a stay will essentially run out the clock on Kalshi’s ability to list contracts for the November 2022 elections.  I believe that it is only fair for either both exchanges to list the political control contracts, or neither of them should.

4. The 2012 Nadex order is not binding precedent on the Commission with respect to the Kalshi political event contracts.

In addition, the Commission should evaluate the issues presented by the Kalshi political event contracts as a matter of first impression.  The Commission’s 2012 order prohibiting North American Derivatives Exchange’s (Nadex) political event contracts was specific to Nadex’s contracts and did not create a broad limitation or rule of general applicability.[26]

3. CONCLUSION

Rule 40.11(a)(1) does not apply to the political event contracts here because they are based upon the underlying activity of political control, which is not an enumerated activity, and there is no additional required public interest test.  Rule 40.11(a)(2) is not operative because the Commission has not determined by rule or regulation that similar activity is contrary to the public interest.  Therefore, the Commission cannot exercise Rule 40.11(c) to require a review and impose a stay of Kalshi’s contracts. However, the Commission can review the political event contracts pursuant to the process set forth under Rule 40.2 or 40.3, as applicable.

Further, when the Commission reviews a contract under Rule 40.2 or 40.3, it includes review for compliance with the CEA and Commission regulations—including section 5c(c)(5)(C) and Rule 40.11.[27]  Indeed, the preamble to the final rulemaking for Rule 40.11 states that the Commission will “consider individual product submissions on a case-by-case basis under § 40.2 or § 40.3,” including the applicability of § 40.11(a).[28]  In addition, the Commission can request comment from the public at any time and does not need to use Rule 40.11 to do so.

The Commission should engage with the public in a transparent manner. Kalshi has proactively and extensively discussed the political event contracts with the Commission and staff over the course of approximately 36 meetings for nearly a year.  Not only that, but Kalshi has also had many meetings with members of Congress.  In all that time, if the Commission had a concern that the political event contracts violate CEA section 5c(c)(5)(C) and CFTC Rule 40.11, or if the Commission did not ever intend to allow the contracts to be traded, then the Commission should have said so. We should say what we mean and mean what we say.

Businesses make material strategic and commercial decisions that have material impacts on their operations and performance, based on regulatory engagement with the Commission.  Lost opportunities may never be regained.  The “regulatory burn rate” is real, and we should be transparent so that businesses can get the information they need to move forward and redeploy capital to more productive use.

I look forward to receiving comments from the public on these important issues.

Commissioner Johnson delivered remarks on digital asset policy, innovation, legislation and regulation at a roundtable at the CFTC, organized by Commissioner Johnson’s Office, the Office of the Chairman, CFTC OMWI, and the inaugural CFTC Chief Diversity Officer.

Remarks as Prepared

In 2008, an unidentified person – or group of people – using the pseudonym Satoshi Nakamoto published a white paper, innocently titled - Bitcoin: A Peer-to-Peer Electronic Cash System - that outlined a decentralized peer-to-peer system for making and processing payments. In the decade since the white paper’s release, we have witnessed exponential growth in the market for digital assets, including cryptocurrencies. Inspired by promises of financial freedom, enticed by advertisements featuring celebrities and tales of instant, high-yield returns, many investors seeking opportunities to build wealth and enter markets on a level playing field part with their hard-earned money and invest in the novel digital market ecosystem.

Among those in the increasingly diverse crypto-investing community, we find a significant population of historically underserved racial and ethnic minorities, senior citizens, active-duty military, and veterans. Some of these investors are expressly drawn to these novel markets by promises of financial inclusion. For others, it is the opportunity to explore entrepreneurial opportunities and increase income, wealth, and resources – a promise that, if realized, may enable them to transition from fragile financial circumstances to achieving the American dream.

Over the last few years, digital asset markets have grown significantly and suffered notable periods of decline similar to the current crypto-winter. In this current period, characterized by persistent volatility, a precipitous decline in pricing, and a notable number of firms facing the decision to declare bankruptcy, we examine the specific implications of crypto-investing for diverse communities and the potential benefits of well-tailored, carefully crafted regulation. As Treasury Secretary Janet Yellen recently observed, while regulations should be “tech-neutral,” “great care must also be applied to ensure innovations do not cause disparate harm to vulnerable communities or exacerbate social, racial, or economic inequities.”[1]

Earlier this summer, in collaboration with my office, the Office of the Chairman, the Commodity Futures Trading Commission’s (CFTC) Office of Minority and Women Inclusion (OMWI), and the CFTC’s inaugural Chief Diversity Officer Tanisha Cole Edmonds launched an important discussion about the promises of inclusion and access for historically marginalized communities in digital assets and cryptocurrencies.

Last week, we continued this dialogue with a roundtable on Digital Assets and Financial Inclusion (Roundtable). We invited some of the many diverse stakeholders who are thoughtful about crafting well-tailored legislation and regulation to join us for the Roundtable, including: Lucy Hynes, Senior Counsel to the U.S. Senate Committee on Agriculture, Nutrition, and Forestry and Committee Chairwoman Debbie Stabenow; Jason Somensatto, FinTech Policy Specialist, Office of the Chairman, CFTC; Rashan Colbert, Legislative Assistant, Office of Senator Cory Booker; Joshua Lobert, Majority Counsel to the U.S. House of Representatives Committee on Agriculture; Kyle Williams, Senior Manager for Public Policy, Coinbase Global, Inc.; Tiffany Smith, Partner, WilmerHale; Joi Chaney, Executive Director, Washington Bureau and Senior Vice President, Policy and Advocacy, National Urban League; Cleve Mesidor, Executive Director, Blockchain Foundation; and Tanisha Cole Edmonds, CFTC Chief Diversity Officer. With stakeholders’ valuable insights, the Roundtable explored the contours of responsible innovation as well as investor protection concerns that may be particularly acute for certain populations in underserved communities.

In describing the markets that the CFTC regulates Commissioner Johnson stated, “the United States boasts preeminent derivatives and commodities markets and we have long served as a global leader in the development of regulation and policy. We must continue to have a seat at the table, particularly as we collaborate to create a whole of government approach across federal and state regulators and cooperate with our international counterparts to establish global digital asset or cryptocurrency policy and regulation thresholds.” Commissioner Johnson explained “the CFTC’s mandate to oversee the U.S. derivatives markets is critical to the stability of the global financial system. Derivatives markets allow market participants to manage their risks and determine fair market prices for underlying assets, including, energy, agriculture, metals, and financial instruments that are integrated in every aspect our lives. The CFTC takes a principles-based approach to regulation that allows for innovation and growth, while also providing necessary customer protections through aggressive enforcement of the Commodity Exchange Act (Act) and Commission’s regulations (Regulations).”

Exercising Existing Enforcement Authority

Since 2014, the Commission has diligently exercised its enforcement authority and initiated over fifty (50) enforcement actions pursuing violations under the Act[2] and Commission Regulations[3] in which the underlying assets were digital assets or cryptocurrencies.[4] Commissioner Johnson explains that “the Commission has filed claims against garden variety fraud in the digital asset and cryptocurrency markets alleging violations of sections 4b, 4o, and 6(c)(1) of the Act[5] and regulation 180.1.[6]” According to Commissioner Johnson “all too often, these schemes have targeted vulnerable or marginalized retail investors.” In the last few months alone, Commissioner Johnson said “the Commission has charged several individuals and entities with perpetrating more sophisticated fraud schemes including Ponzi schemes and the first digital asset “pump-and-dump” case brought by the CFTC.”

The CFTC’s Division of Enforcement has taken significant efforts to ensure that, consistent with our mandate, the agency is effectively policing against other violations of the CEA as well. In furtherance of these efforts, the CFTC has filed charges against entities for violations including engaging in off-exchange futures and commodity options transactions and failing to register as Futures Commission Merchants, Swap Execution Facilities, or Designated Contract Markets.[7] In addition, the CFTC has charged entities for failing to comply with regulations requiring implementation of anti-money laundering, customer identification, and know-your-customer protocols and procedures.[8]

President Biden’s Executive Order

On March 9, 2022, President Biden issued the Executive Order 14067 entitled “Ensuring Responsible Development of Digital Assets,” (“Executive Order”). The Executive Order provides a comprehensive outline of U.S. policy objectives with respect to digital assets, including:

• Protection of consumers, investors, and businesses in the U.S.;
• Protection of the U.S. and global financial system and the mitigation of systemic risk;
•  Mitigation of illicit finance and national security risks posed by misuse of digital assets;
• Reinforcement of U.S. leadership in the global financial system and in technological and economic competitiveness, including through the responsible development of payment innovations and digital assets;
• Promotion of access to safe and affordable financial services; and
• Support of technological advances that promote responsible development and use of digital assets.[9]

The Executive Order marked an important step towards greater cooperation and coordination among cabinet-level agencies, market regulators and prudential regulators. Yet, much work remains. Parallel with growth in the digital asset market, Commissioner Johnson said, “we must increase investor education and outreach to empower consumers and contemporaneously combat illicit activity and safeguard the integrity and stability of our financial markets.”

Pending Legislation Designed to Better Protect Consumers and Enhance Market Structure and Market Integrity in Digital Assets and Cryptocurrency Markets

The Roundtable discussion centered on several proposed legislative acts and their potential impact on market participants and consumers. Lucy Hynes provided an overview of the Digital Commodities Consumer Protection Act of 2022 (DCCPA), a bi-partisan bill, introduced by U.S. Senate Committee on Agriculture, Nutrition, and Forestry Chairwoman Debbie Stabenow and Ranking Member John Boozman and co-sponsors Senators Cory Booker and John Thune.[10]

Ms. Hynes noted that the DCCPA seeks to give the CFTC jurisdiction over digital asset spot market transactions by expanding the definition of “commodity” in the CEA to include “digital commodities.” She further noted that the bill includes registration mandates requiring any entity acting as a digital commodity platform to register with the Commission in one or more of the applicable categories (i.e., digital commodity broker, digital commodity custodian, digital commodity dealer, and digital commodity trading facility). The DCCPA also includes an obligation for Digital Commodity Platforms to comply with all applicable core principles, which are designed to protect customers and the integrity of the digital commodity marketplace. Jason Somensatto explored other pending and forthcoming legislation, including a review of the bi-partisan Responsible Financial Innovation Act introduced by Senators Cynthia Lummis and Kirsten Gillibrand.[11] Mr. Somensatto emphasized that the Responsible Financial Innovation Act is a comprehensive reform measure that introduces the concept of “ancillary assets” as a pathway for clearly defining oversight of digital assets and cryptocurrencies as securities or commodities.[12] 

In addition, Rashan Colbert provided a detailed review of Section 7 of the DCCPA, which would require the CFTC to conduct a study on the impact of digital assets on diverse communities. Rashan described how the bill reflects the notion of inclusivity and asks the Commission to examine the racial, ethnic, and gender demographics of the digital asset investment community. This data will offer clarity regarding investor demographics, facilitate the development of effective, thoughtful consumer protections, enable the drafting of tailored rules and regulations that foster access and inclusion where appropriate, and mitigate hurdles to market participation and inequities in access.  

Doubling-Down on Investor Protection

As retail market participation becomes more prevalent in digital asset markets as compared to other commodity futures markets, it is imperative to protect retail market participants with sound regulation, enforcement, and educational outreach.[13]

The CFTC must maintain high standards of enforcement and educational outreach to protect retail participants in the cryptocurrency market—a group that includes greater representation of younger and diverse investors.[14] A June 2022 report by the Federal Reserve Bank of Kansas City highlights the disparities among the investor population in cryptocurrency and digital asset markets based on race, ethnicity, gender, level of education, and financial resources.[15] The report indicates that historically underserved groups have higher levels of participation in the crypto-investment community than the investment communities for traditional financial products.[16] Diverse and young investors are also more likely to view digital assets or cryptocurrency investments as “as less risky” and “more attractive” investment opportunities.

Joshua Lobert echoed the notion that legislation should be inclusive but emphasized that “one size does not fit all.” It is important for legislation to reflect careful consideration of how regulation may impact different communities. Mr. Lobert also emphasized the importance of initiating outreach efforts to ensure the intended information reaches all customers. Tiffany Smith posited that it is imperative to appreciate the distinction between increasing access to financial markets through cryptocurrency and digital asset offerings and enhancing inclusion.

Cyber Security Concerns

Since 2012, digital asset and cryptocurrency exchanges or trading platforms have experience dozens of significant cyber-attacks attacks. The frequency and severity of these security breaches raises alarms. Over the last decade, hackers have stolen approximately $2.7 billion from cryptocurrency trading platforms or exchanges. For example, Mt. Gox, which reportedly at its peak accounted for 80 percent of the global bitcoin trading volume, declared bankruptcy in early 2014 after suffering cyberattacks that led to the loss of an astounding 850,000 bitcoin.[17] In January of this year, another large cryptocurrency exchange with a global footprint, confirmed losing $30 million, stolen from over 400 customer wallets after a breach of multiple levels of their cyber security protocols.[18] 

Cyber-attacks threaten all financial institutions, but the threat to fintech firms, like those operating in cryptocurrency markets, is amplified, in part, due to the potential that firms in nascent stages of development may lack of well-developed system safeguards. It is critical to ensure that cryptocurrency trading platforms routinely evaluate and anticipate cyber security vulnerabilities, particularly as they relate to the protection of customer funds.

Participants raised several additional issues that impact equity and inclusion and merit careful consideration, yet – in our limited time – we were unable to fully explore. For example, how might increasing use of digital assets or cryptocurrencies impact, consumer financial data privacy? Developing faster, more efficient, less expensive payment or remittance systems or platforms may ease burdens and draw certain communities to the digital asset ecosystem. Consequently, it will be important to ensure the availability of parallel consumer data protections and to guard against disparities that may lead to less rigorous consumer data protections.

Kyle Williams reiterated the industry’s need for regulatory clarity, as well as a robust yet flexible framework to foster growth and innovation. Joi Chaney and Cleve Mesidor both emphasized the need to incorporate community service and investor advocacy leaders from underserved groups, including those who have long been active in the digital assets space, and to empower customers. Tanisha Cole Edmonds affirmed the need for decision-makers to listen to a diverse range of perspectives, and explained how the CFTC’s diversity, equity, and inclusion efforts align with the inclusion goals discussed at the roundtable.

Conclusion

“It is vital for the U.S. to bolster its role as a leader in the global financial system by developing a strong regulatory framework for digital assets,” Commissioner Johnson explained. “I would also emphasize that our markets are global and, consequently, underscore the importance of fostering international cooperation. Our global financial system, like this new technology, increasingly operates as frictionless, cross-border network. We must reinforce our willingness to work with our counterparts around the globe to ensure the integrity and soundness of our markets.”

Commissioner Johnson noted that “recently proposed legislation indicates the direction of travel that Congress may take and will enable market regulators and prudential regulators to begin to make progress in establishing the requisite regulatory infrastructure for these nascent markets and prevent bad actors from exploiting regulatory gaps or weakening in our financial system.” Commissioner Johnson explained that “the CFTC is committed to its mission of promoting the integrity, resilience, and vibrancy of the U.S. derivatives markets through sound regulation.”  “I am confident,” Commissioner Johnson explained “that by working together, we can foster responsible innovation and develop effective regulation that promotes inclusion and opportunity for all as well as proper safeguards and education resources to protect vulnerable customers.”

Finally, I would like to thank all of the distinguished panelists who participated in the roundtable - Joi Chaney, Rashan Colbert, Tanisha Cole Edmonds, Lucy Hynes, Joshua Lobert, Cleve Mesidor, Tiffany Smith, Jason Somensatto, and Kyle Williams. I look forward to continued dialogue on this important issue.

I respectfully concur with the final rule updating the CFTC’s interest rate swap clearing requirement regulations.  Pursuant to the Commodity Exchange Act (CEA) and the Commission’s regulations, subject to Commission determination, certain interest rate swaps are required to be submitted for clearing to a derivatives clearing organization (DCO) registered under the CEA or a DCO exempted from registration under the CEA.[1]  The final rule updates this set of interest rate swaps required to be cleared in light of the global transition from reliance on certain interbank offered rates (IBORs) such as the London Interbank Offered Rate (LIBOR), to alternative reference rates, which are predominantly overnight, nearly risk-free reference rates (RFRs).  This rulemaking is an essential part of that transition.  I commend the CFTC staff for their work here, as well as for their leadership in a historic global effort by the CFTC alongside other regulators, international bodies such as IOSCO and FSB, cross-jurisdictional working groups, financial market infrastructures, swap dealers, other market participants, and more, to reform the global interest rate swap market and benchmarks.

I would like to note, however, a few points.  I believe in international harmonization and a practical approach wherever possible.

First, with those principles in mind, we should not impose a clearing requirement for CHF Swiss Average Rate Overnight (SARON) swaps or SGD Singapore Overnight Rate Average (SORA) swaps until the Swiss authorities or Singaporean authorities, respectively, adopt their own swap clearing requirements for those swaps.[2]

Second, absent a compelling reason otherwise, I would support an October 31, 2022 effective date, rather than 30 days after publication in the Federal Register, for the overnight index swaps (OIS) referencing RFRs covered by the rulemaking, consistent with the Bank of England’s proposed effective date.[3]  This would be consistent with principles of international harmonization and also would recognize the implementation requirements associated with any rule changes.  For example, as raised by commenters, complying with new clearing requirements requires market participants to “adapt systems; create and run internal training; issue client communications; and develop and implement control frameworks, internal governance; and address unique jurisdictional requirements where they exist.”[4]  We should recognize and take a practical approach to the very real implementation issues and operational challenges like these which necessitate sufficient planning and time.

Finally, I note two issues relating to the IBOR transition that are identified as beyond the scope of the rulemaking.  These relate to trade execution requirements and to post-trade risk reduction.[5]  We should consider these issues further as appropriate. 

In the fall of 2008, global financial markets reeled as evidence emerged indicating that market participants failed to effectively manage risks in the then-unregulated $400 trillion (notional) swaps market.  The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) directed the Commodity Futures Trading Commission (Commission) to develop and implement formal rules, and bring the swaps market under the ambit of the Commission’s authority.[1]  The Commission introduced clearing requirements, a vital regulatory tool that has increased transparency and promoted market integrity.

Clearing Requirements

To determine which swaps are subject to clearing requirements, the Commission examines several transaction-based risk factors.[2]  In accordance with this approach, the Commission later determined that swaps that reference Interbank Offered Rates, or IBORs, including most notably the London Interbank Offered Rate—LIBOR, would be subject to clearing requirements.  For decades, these global benchmark interest rates have served as the dominant rate setting standards for market participants around the world.  Market participants have employed these reference rates to determine interest rates that impact financial agreements in almost every sector of the economy—including significant volumes of swaps and futures contracts, commercial and personal consumer loans, and home mortgages.[3]  U.S. Dollar LIBOR, for example, has for decades served as the basis for the settlement of the three-month Eurodollar futures contract listed on the Chicago Mercantile Exchange—one of the most liquid financial derivatives contract that has ever traded.[4]  Significant notional amounts of swaps and loans also referenced U.S. Dollar LIBOR.[5]

Transition to Alternative Reference Rates

Even though the clearing requirement for LIBOR and other IBORs have reduced certain risks arising from the origination and trading of swaps, the clearing requirement did not eliminate risks inherent in the manner these reference rates were calculated.  Determinations of LIBOR and other IBORs were based on submissions received from a relatively small and select panel of major banks.  These rates were calculated and published daily for several different currencies by the British Banker’s Association.  While the rates were intended to reflect the cost to the banks of borrowing unsecured funds, evidence revealed through a number of enforcement actions brought by the CFTC over the past decade demonstrated marked manipulation of the submitted rates.[6]  In order to protect investors from this misconduct and to preserve market integrity, the CFTC and other regulators, including the Bank of England, have been overseeing a market transition away from LIBOR and other IBORs to replacement rates based primarily on risk free rate overnight index swaps (RFR OIS).[7]  In addition, as a result of the enforcement actions and other market shifts, the volume of interbank lending transactions upon which these rates were calculated has declined, leading to additional concerns regarding the integrity and reliability of the rates.[8]  As a result, the Commission seeks to amend its Part 50 clearing requirements to remove all LIBOR and related IBOR interest rate swap clearing requirements and introduce clearing requirements for swaps referencing the corresponding RFR OIS.

The comments received in response to our notice of proposed rulemaking earlier this year support this proposal.  Moreover, this final rule represents the culmination of years of work by the Commission as well as its counterparts across the globe to ensure a more reliable, more transparent set of interest rate benchmarks.  In collaboration with our international colleagues’ efforts in jurisdictions around the world, the Commission’s efforts to adopt and implement this final rule serves to preserve the stability and integrity of our markets and to reduce the systemic risks that precipitated the financial crisis.  Accordingly, I support the Commission’s modification of its clearing requirements and transition from LIBOR and other IBORs to the RFR OISs.

Yesterday, the Commodity Futures Trading Commission (CFTC) filed an injunctive action in the Southern District of Ohio against Rathnakishore Giri (Giri) and his companies, SR Private Equity, LLC and NBD Eidetic Capital, LLC.  As alleged in the complaint, Giri engineered and perpetuated a Ponzi scheme designed to defraud investors interested in investing in digital assets.  Under the guise that he operated a private equity investment fund with a focus on investing in digital assets, Giri seized upon the contemporary fervor for digital asset investment opportunities and lured unwitting investors to contribute over $12 million in cash and bitcoins to his funds with the promise of exceptional returns without the risk of financial loss.

The complaint alleges that Giri enticed his customers by making false and misleading statements touting his experience, guaranteeing customers profits, and ensuring customers that they could withdraw their initial investment and profits at any time.  The complaint also alleges that rather than using customer funds to acquire and trade digital assets as promised, Giri simply pocketed customers’ money, using their invested funds to bankroll his lavish lifestyle—characterized by use of private jets, yacht rentals, an extravagant vacation home, a luxury car, and expensive clothing.  In other instances, Giri distributed newly solicited investors’ contributions to existing investors, misleadingly describing the contributions as the “profits” of the funds’ successful trading strategies.  While the CFTC rigorously surveils markets and enforces regulations in accordance with its mandate to protect customers, novel financial products may create new challenges.  Identifying and policing fraud in these emerging markets may be difficult or delayed in light of the agency’s limited visibility in these markets.

It is imperative that all market participants understand that such conduct will be subject to enforcement actions in accordance with our mandate.  Recent attraction to digital assets and cryptocurrency market firms proclaiming high yields or promising instant wealth, but obscuring deceptive schemes that borrow from long-prohibited behavior is deeply concerning.  While there are many benefits to responsible innovation, customers must remain vigilant.  Fraudsters who seek to take advantage of an unsuspecting public will exploit popular interest in innovative financial technology and perpetrate scams that separate investors from their hard-earned money.  This case illustrates these dangers, underscores the ever-present threats, and demonstrates that—no matter the asset class—effective enforcement and customer protections must be among our highest priorities. 

I applaud the diligent work of our Enforcement team including Dmitriy Vilenskiy, Karen Kenmotsu, Luke B. Marsh, and Paul G. Hayeck, who filed this case and continue to pursue justice for the victims.

I support the Commission’s amended clearing requirement for swaps referencing rates less susceptible to manipulation than the London Interbank Offered Rate (“LIBOR”) because it promotes market integrity and supports the risk-mitigating benefits of central clearing.  I thank the CFTC staff for their work on this and other efforts to support the transition away from LIBOR.

Clearing Requirement

The 2008 financial crisis revealed how over-the-counter derivatives could render market participants vulnerable to the weaknesses of their counterparties and leave the markets and regulators in the dark about risks.  Pre-crisis, risks were hidden, and firms were vulnerable to interconnected and complex, bilateral transactions.  This contributed to the failure of many banks and financial institutions.  American households paid the price, left with the catastrophic consequences of a near meltdown of the U.S. financial system, a housing crisis, the inability to access credit, and an unprecedented government bailout.

One of the most critical reforms in the Dodd-Frank Act was a framework to channel swaps through central clearing, thereby reducing risk and increasing transparency across U.S. financial markets.  The CFTC has been a global leader in driving swaps trading into centralized clearing, and coordinating with international regulators in a globally harmonized approach. 

Central clearing has lived up to its promise.  The markets, investors, end users, and regulators have benefited from increased visibility into swap exposures and from reduced interconnectedness and complexity.

LIBOR Transition

Reliable and sound benchmark rates promote market integrity and protect the American public.  A decade ago, allegations of LIBOR manipulation led to investigations by government authorities, including the CFTC, that resulted in billions of dollars of penalties and other sanctions.  These investigations revealed that a handful of dominant players profited from manipulating LIBOR and markets, including U.S. mortgage markets.  Here again, American households paid the price. 

Through significant coordinated efforts across the public and private sectors, great progress has been made to transition towards sounder, alternative reference rates – namely, overnight, so-called “nearly risk-free” reference rates.  Today’s final rule amends the CFTC’s swap clearing requirement to account for the continuing shift in liquidity to these more reliable rates.  Market reliance on USD LIBOR has already considerably decreased, and we have experienced significant liquidity in, and voluntary clearing of, swaps referencing the Secured Overnight Financing Rate (“SOFR”).  We aim to bolster and accelerate this shift and ensure the risk-mitigating benefits of clearing continue to be realized in the evolving interest-rate swaps markets.

The final rule also reflects the CFTC’s longstanding priority of harmonizing with international regulators.  The certainty of the CFTC’s timeline for adding interest rate swaps referencing USD SOFR to its clearing requirement, and for removing interest rate swaps referencing USD LIBOR, should assist international regulators who are also revising clearing requirements for these swaps. 

Given the global nature of financial markets, international coordination is necessary in order for the LIBOR transition to be successful.  International coordination will also help to ensure that central clearing remains a cornerstone of post-crisis financial reforms. 

Transparency is an integral component of the regulatory framework that ensures the safety and soundness and enduring preeminence our financial markets.

Working in collaboration with our colleagues at the Securities and Exchange Commission (SEC) to enhance oversight and improve visibility through thoughtfully designed and well-calibrated collection approaches is consistent with our mission and statutory mandate—to “insure the financial integrity of all transactions subject to this Act and the avoidance of systemic risk.”[1]

The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act)[2] incorporated innovative regulatory features for promoting the stability of the US financial system, including establishing the Financial Stability Oversight Council (FSOC) to monitor for emerging systemic risks that could significantly impact our financial markets and American consumers.[3]

Today’s proposal seeks to further our commitment to achieving these values.  Consequently, I support issuing for comment the proposal to amend Form PF, and look forward to the thoughtful, substantive contributions that the proposed amendments will engender.

Congress in drafting the Dodd-Frank Act recognized that risks with systemic import are best monitored through collaboration amongst the US financial regulators, each with distinct regulatory mandates, and leveraging their resources and expertise to support FSOC’s overarching responsibilities.  Form PF reflects these statutory qualities.  As directed by the Dodd-Frank Act, the Commission and SEC in 2011 jointly issued rules to provide FSOC with important information about private fund operations and strategies through Form PF.[4]

The private fund industry has only grown in size and importance since 2011.  In the third quarter of 2021, private funds reported a staggering $12 trillion of assets on Form PF.[5]  The sheer aggregate size of private funds signifies the potential for events in this industry to produce reverberating effects on the integrity of our financial markets and, in turn, remarkably influence the welfare of American consumers.  Form PF over the last decade has provided financial regulators with needed transparency into this potentially systemically significant sector of the financial system.[6]   

I support the Commissions’ endeavor to build on data collection points that need clarity and to propose revisions in response to changes in financial markets as well as market participants and regulators’ experience with Form PF as a tool for gathering information.  Over the last decade, private funds have adopted new practices, investment strategies and an appetite for investing in non-traditional assets.[7]  The proposed revisions to Form PF aim to adapt to these developments as informed by experience in administering Form PF.

Notwithstanding these important gains, I note that it will be important to hear from and consider the concerns raised by all stakeholders, including for example, concerns regarding the costs and challenges of reporting, particularly for smaller entities.  I anticipate the proposal to amend Form PF will engender important substantive contributions that will refine our understanding of the benefits of data collection, enhance transparency, and improve our ability to preserve the integrity of our markets.

[1]  Section 3(b) of the Commodity Exchange Act, 7 U.S.C. 5(b).

[2]  Public Law 111–203, 124 Stat. 1376 (2010).

[3]   See Sections 111 and 120 of the Dodd-Frank Act.

[4]  Reporting by Investment Advisers to Private Funds and Certain Commodity Pool Operators and Commodity Trading Advisors on Form PF, 76 FR 71128, 71129 (Nov. 16, 2011).

[5]  Amendments to Form PF to Amend Reporting Requirements for All Filers and Large Hedge Fund Advisers (Voting Copy – As approved by the Commodity Futures Trading Commission on 8/10/2022) (Proposed Rules) at 8 n.7, https://www.cftc.gov/media/7536/votingdraft081022Parts275and279/download.

[6]   See Proposed Rules at 150.

[7]  Proposed Rules at 7–8.