Washington, DC —Commodity Futures Trading Commission (CFTC) Commissioner Brian Quintenz released the following statement in response to CFTC Chairman Giancarlo’s announcement on the de minimis threshold:

“Some have described the current de minimis threshold of $8 billion in notional value as a ‘loop hole,’” said Quintenz. “In reality, its scheduled reduction to $3 billion would create a “black hole,” sucking in community banks and end-users who pose zero systemic risk. For far too long, too much uncertainty has surrounded the de minimis threshold’s reduction and its damaging economic consequences. While we should always consider new data in the ongoing evaluation of public policy, it is well past time to address this issue head-on, finalize a rational and effective threshold, and provide the market with clarity. I look forward to working with the Chairman and Commissioner Behnam to complete our consideration of this issue.”

As prepared for delivery

Good morning Chairwoman Stabenow, Ranking Member Boozman, and members of the Committee.  I am honored to appear before you today for the first time as Chairman of the Commodity Futures Trading Commission (CFTC).  I appreciate the opportunity to share my views on digital assets, and look forward to working with this Committee as we collectively address the many issues related to this emerging technology.

The CFTC’s Role as a Market Regulator

The CFTC is the primary regulator of the U.S. derivatives markets in which commodity futures, swaps and options are traded.  For over a century, the derivatives markets have played an integral role in the U.S. economy, facilitating risk management and price discovery, and contributing to financial stability and predictability of prices that impact the daily lives of all Americans.  Through the Commodity Exchange Act, Congress both mandates and empowers the CFTC to implement rules and regulations aimed at fostering open, transparent, competitive, and financially sound markets; to prevent and deter misconduct and disruptions to market integrity; and to protect all market participants from fraud, manipulation, and abusive practices.

Part of our role in ensuring the integrity of derivatives markets demands that the agency understand a great deal about underlying reference cash markets – where producers, including farmers and ranchers, manufacturers, and institutional investors directly exchange agriculture commodities, energy products, precious metals, and even digital assets.  As history demonstrates, the potential for fraud or manipulation in these underlying markets often poses the most immediate threat to the integrity of derivatives markets.

While the CFTC does not have direct statutory authority to regulate cash markets, it does have fraud and manipulation enforcement authority.  Accordingly, when the CFTC becomes aware of potential fraud or manipulation in an underlying market, either through regular oversight and surveillance programs, or through other means such as a whistleblower tip or referral, we address the misconduct through our enforcement authority.

The Commission’s exercise of its enforcement authority as applied to both the derivatives and underlying reference cash markets and resulting judicial interpretation has provided an effective means of protecting customers and market integrity for decades.  It is a feature of the system created in our statute, providing legal certainty within jurisdictional markets that are constantly evolving against a regulatory system that may not always keep pace.  And while the crystallization of our enforcement authority through judicial interpretation has proven an effective means of uncovering and addressing some of the regulatory gaps presented by innovation and evolution in the financial markets with respect to digital and related assets, it cannot be viewed as a viable substitute for a functional regulatory oversight regime for the cash digital asset market.

This is not to diminish the fact that many cash commodity markets benefit from federal oversight.  However, the digital asset market, which at present is most directly supervised through state money transmitter licenses, is unique and presents many novel issues for the CFTC, given our limited authority to police these volatile markets.  In fact, there is no one regulator, either state or federal, with sufficient visibility into digital asset commodity trading activity to fully police conflicts of interest and deceptive trading practices impacting retail customers.

The Digital Asset Market

There are now hundreds of thousands of unique digital assets in circulation with a combined market capitalization of approximately $2 trillion.  At the center of this burgeoning industry are the trading platforms where most investors access this market.  Several of these platforms operate on a global scale and host marketplaces for trading both in the underlying digital assets, as well as derivative contracts referencing those assets.  According to public data, every month in 2021 except one saw over $1 trillion in monthly trading volume in the digital asset cash market, with a high of $2.23 trillion in trading volume in May 2021.[1]   And the derivatives market is even larger, with notional exchange volumes in just bitcoin futures surpassing those numbers.[2]

Although the CFTC’s core responsibility is regulating the commodity derivatives market, there are several unique elements of the digital asset commodity cash market that distinguish it from other cash commodity markets, suggesting it would benefit greatly from CFTC oversight.  For example:

• Unlike most cash commodity markets, which are dominated by wholesalers and large financial institutions facilitating the transfer of commodities for commercial use and consumption, the cash market for digital assets is currently characterized by a high number of retail investors mostly engaged in price speculation.
• The speculative fervor around digital assets, frequently feeling like a modern gold rush, has led many investors to regularly take on high levels of leverage when trading, leading to heightened price volatility, often exacerbated by cascading liquidations during price downturns.
• Most investors in the cash market entrust their digital assets to the platforms upon which they trade, failing to differentiate this type of custody arrangement from that offered by the traditional regulated banking industry. The technical complexities around securing and transacting in digital assets, particularly issues around custody, have resulted in numerous platforms losing funds to hacks, exploits, and poor cyber security.

I believe these unique characteristics, combined with the growing size and customer, operational, and potential future financial stability risks associated with the cash market necessitate a proactive federal regulatory approach to ensure that the standards that American investors have come to expect from our financial markets are equally present in digital markets. 

I also believe that in order to reach the lofty goals that many of the technology’s most ardent proponents advocate, it is important that we find ways to sensibly bring this emerging market within the regulatory fold.  If in fact the future global economy holds a place for digital assets, tokenization, blockchain technology, decentralized finance, and other elements of the FinTech driven ecosystem, then the need to uphold American leadership and stewardship of this technology is clear.  Critical issues, such as national security, trade, and effectively addressing climate change risks, to name a few, will also be at stake.

The CFTC’s role in the Digital Asset Commodity Market

The digital asset industry in the U.S. does not fall under a single comprehensive regulatory regime. Instead, the CFTC and other federal agencies and state regulators have all been responsible for collectively establishing the existing, and very incomplete, regulatory environment.  And while our oversight capabilities are generally complimentary, market regulation and financial supervision often rely on the development of cooperative arrangements.  This is made more difficult by the rapid emergence and development of the digital asset market which, by design, has largely taken place on the outskirts of the traditional financial market structures. While it cannot be said that the industry is completely unregulated, there are important principles missing from this framework that we see in other federally regulated markets, particularly ones that primarily cater to retail investors.  

Since 2014, the CFTC has been aggressive in using its limited fraud and manipulation authority in the digital asset space.  The CFTC has brought nearly 50 enforcement actions, overseen an increasing number of registrants offering digital asset based derivative products, and established dedicated internal functions to stay abreast of the technical innovations fueling this market.

However, many challenges remain, and the digital sector now demands more and more of the CFTC’s attention and time, which I believe necessitates additional resources to adequately address these issues.  We are past the stage where digital assets and decentralized financial technologies are a research project, sandboxing what may come in the future.  The issues are at the front and center of our thinking at the Commission in addition to our traditional regulatory, oversight, and enforcement responsibilities.

The CFTC is well situated to play an increasingly central role in overseeing the cash digital asset commodity market.  Fundamentally, the CFTC is a market regulator that ensures market integrity and vibrancy aimed at supporting financial stability, while ensuring individual customer protections through principles-based oversight of exchanges, clearinghouses, data repositories, and market participants. This flexible approach has allowed the CFTC, with authority from Congress, to evolve along with the derivatives markets from their historical roots in overseeing agricultural markets to now overseeing markets in everything from energy and precious metals to financial indices and swaps.  And we now stand ready to do the same within the digital asset commodity market.

The Road to Come

As Chairman, I will ensure that the CFTC continues to use our existing enforcement authority to its fullest extent in the digital asset commodity space to protect customers from fraud and manipulation.  However, it is important to recognize that the challenges in this space going forward are likely to extend beyond the confines of the Commodity Exchange Act.

The nature of this innovation results in impacts to more than just financial markets. We are seeing several government agencies consider how this technology impacts federal policy related to payments, custody, illicit activity, national security and a host of other issues.  Additionally, reports regarding energy usage resulting from mining are staggering, often times being compared to that of entire countries.  On this note, I believe any regulatory response to digital assets must include measures to bring additional transparency to the conduct that makes this innovation possible.  Internally, I have directed the CFTC’s Climate Risk Unit and LabCFTC to examine the climate implications of digital assets.  Staff have also begun initial communications with other federal agencies to ensure the knowledge and expertise of the whole federal complex is brought to bear on this challenge.   

I wrote in 2019 that “where the technology could become a common and social good rather than a significant threat to financial stability, the regulatory patchwork is our greatest hurdle to mainstreaming integration and adoption.”[3]  As a result, I expect there will be an increasing need to ensure a coordinated federal approach in this area, and I plan to have the CFTC be a proactive participant in this process, whether building on the strong relationship the CFTC shares with the Securities and Exchange Commission, or contributing to broader efforts like the recent President’s Working Group report on stablecoins.

I believe many of the CFTC’s regulatory principles that have made the U.S. derivatives markets the strongest in the world can also serve to aggressively address many of the risks of digital assets.  Since its inception, the CFTC and its markets have been at the forefront of innovation and technological development.  We have also been a forceful and disciplined cop on the beat.  The continued emergence of digital asset technology presents risks and opportunities, and the CFTC stands ready to leverage its expertise and experience to confront both.

Thank you for your time and I look forward to answering your questions.

The Commission’s Division of Data has today issued a no-action letter providing approximately six additional months for market participants to work through challenges associated with complying with the amendments to swap data reporting regulations recently adopted by the Commission.[1] I believe the Staff’s action is appropriate. Market participants represent that they need this additional time to overcome certain operational and technological issues and to build and test changes to their swap data reporting systems. 

As market participants continue to work through challenges associated with the implementation of these amendments to the swap data reporting rules in Parts 43, 45, 46, and 49 of the Commission’s regulations (the “Amendments”), the Commission has considerable work to do, too.

Block Trade Thresholds 

When we adopted the Amendments in the fall of 2020, I stated, “I believe that the driving force behind the substantial rewrite of the swap data reporting rule set we are adopting today is that the Commission is not confident in the quality of [swap data repository] data, and that an overhaul is needed to provide the CFTC with complete and accurate information for data-driven policy decision making.”[2] Yet, despite the data reliability challenges that necessitated adopting the Amendments, the Commission chose not to re-assess the block size thresholds with the improved data that will result from the Amendments. 

As such, the block size threshold of 67 percent notional that was adopted in 2020 is an arbitrary metric. The 67 percent number was chosen back in 2013, and even then, the Commission contemplated the possibility of adjusting it once reliable swap data was available.[3] In fact, in 2013, the Commission decided that an initial calculation (50-percent threshold notional) was appropriate to determine block sizes, and that it would be followed by implementation of a higher block size threshold (67-percent threshold notional) when one year of reliable swap data was available.[4] Yet, no such one-year period has materialized due to less-than-reliable swap data. Despite the absence of reliable data, the Amendments nevertheless finalized the arbitrary 67 percent notional metric.

At the time of adopting the Amendments, I further stated that “It is unclear what, if any, Commission or staff analysis might transpire between the effective date of the swap data reporting rules (18 months) and the block size threshold compliance date (30 months). I intend to ensure that any input received will be taken seriously, notwithstanding its retrospective nature and the fact that it is well beyond many of our terms of office. I wish for the Commission to soon hold a formal forum to receive input from affected market participants, especially end users in these markets, such as those who manage teacher retirement and college savings plans for millions of Americans. It is that input, and reliable data reported pursuant to the enhanced reporting rules we are adopting today, on which the Commission’s block determinations should be based.”[5]  

Today, I am reiterating my call that the Commission initiate a request for information with regard to the cap and block thresholds that were derived without reliable data and without public input. 

Substituted Compliance 

The Commission must also turn its attention to a principles-based analysis of swap data reporting regimes in other jurisdictions. While efforts have been made to harmonize where possible, each jurisdiction’s reporting rules will undoubtedly retain some unique characteristics. Substituted compliance is essential considering the global nature of the swaps markets and that, currently, over 60% of CFTC-registered swap dealers are non-US persons.

Conclusion 

It is critical that the Commission’s policy decisions be supported by good data. I expect market participants to work diligently toward resolving the operational and technological issues they have encountered in complying with the Amendments. I also expect the Commission to use that data to support its policy decisions—especially decisions that affect the liquidity and transparency of our markets. And finally, I hope that our attempt to better align swap data reporting rules internationally will at last permit much needed international deference among the various regulatory bodies who long ago committed to improving swap data for the benefit of these global markets. 

As prepared for delivery

Introduction

Good afternoon.  I am delighted to join you virtually today for my first keynote as CFTC Chairman.  I want to thank Katie Trkla and the Vice-Chairs and Conference Chairs for holding this important event and for including me and so many of our key CFTC leaders.

In preparing for this first opportunity to share my vision for the Commission as its Chairman, Katie shared the conference’s draft agenda with me.  As I scrolled down, I paused at the highlighted and italicized note at the bottom of the first page, “Subject to Change.”  Always a good reminder when putting these types of remarks together—and beyond.  If I have learned anything during these last years as a CFTC commissioner and Acting Chairman, it’s the importance of having a strategic, mission-driven agenda supported by a sound -- but flexible -- infrastructure.

A few years back, I was asked to remark on what I thought success looked like for a CFTC Commissioner.  This was before our daily actions were informed by the global pandemic, the proliferation of DeFi and FinTech, the rise of retail participants, more frequent and extreme global climate related events, and the increased recognition of inequity and inequality within our markets and our day-to-day lives.

In answering that question, I considered what success for the Commission looks like.  At the time, I said, “I believe[d] that success for the Commission looks like what it has always looked like: fostering open, transparent, competitive, and financially sound markets; preventing and deterring misconduct and disruptions to market integrity; and protecting all market participants—whether institutional, retail or otherwise—from fraud, manipulation, and abusive practices.”[1]  I also remarked that success requires vigilance so as not to become overconfident in the systems we’ve built.  I stressed that we must remain nimble in our reconsideration of past policies and practices as we prepare for the challenges to come.[2]

In short, I endorsed our mission, rooted in the findings and purposes of the Commodity Exchange Act (CEA),[3] and observed that defining the goals and objectives we pursue in executing that mission remains perpetually “subject to change.”

At the time, I believed that my success as a Commissioner would therefore be defined by my ability to ensure that interested parties were incentivized to work collectively in addressing issues, moving beyond differences in our preferred approaches, and collaboratively identifying and addressing new and emerging risks with knowledge gained from a decade of recovery and almost a century of history.[4]

It’s been a few years since then, and a lot has happened.  And while the Commission is currently down to a dynamic duo, my views on success for the Commission and myself as the Chairman have not been the subject of change -- only the goals, strategies, and plans for getting there have.  With that, I would like to share my vision and preview the strategic plan for how the Commission will pursue its mission and the issues at the forefront of the policy agenda.

The Innovative Elephant in the Room

As many in the industry and the media are quick to bring to our attention, there is a growing concern that key areas of CFTC oversight have been so impacted in recent years by rapid technological innovation that there is a growing divergence between our regulations and the current marketplace.  Associated with this view is often criticism that regulators cannot push ourselves past our own inertia.  The quick to judge point to regulatory turf battles or the battleground itself, riddled with procedural potholes and abandoned, underdeveloped ideas awaiting resuscitation.  However, those of us who are in the trenches have a different perspective and silence ought not always be mistaken for the sound of retreat.

Rest assured, we do know how to do hard things, and we are comfortable doing them as part of our core mission.  Congress granted the CFTC broad authorities within the CEA to both regulate and define the scope of entities and activities that may fall within our jurisdiction.  One such authority extends to cash market transactions.  It is understood that the Commission may review cash market operations of exchanges and their members, and prevent and act against fraud or manipulation by any person in such markets.  The Commission’s broadest authority in such an instance resides in the power to investigate in order to implement and enforce the CEA and Commission regulations.

The Commission more generally exercises its authority through the issuance of rules and regulations.  While the Commission has historically refrained from exercising its cash market authority to its full potential as a policy of restraint, the Commission’s exercise of enforcement authority and resulting judicial interpretation has provided a meaningful, albeit sometimes imperfect, means of protecting customers and market integrity.  However, I view the use of our enforcement authority to crystalize our law through judicial interpretation more as a feature of the system than a bug.  Our Federal Court system is built on the idea of finding the truth of the matter—it is a proven process both for protecting customers and for giving accused wrongdoers the opportunity to be heard.  The process provides certainty, not uncertainty.

I say all of this because the Commission’s exercise of its enforcement authorities to address misconduct that has a direct impact on CFTC jurisdictional markets, affects the larger economy, causes public harm, or interferes with market integrity is just one facet of our approach in innovation and evolution in the financial markets.  I have persistently advocated for a more direct conversation regarding how innovative products and services fit within current legal and regulatory frameworks.  Further, how can the Commission best serve technologists, market participants, customers, and the public in determining the need for additional rules or policy?[5]  And, should Congress step in?  Our goal in this regard is to work collaboratively with all stakeholders to establish appropriate principles and structures in furtherance of well-reasoned and targeted regulation.

As more institutional traders migrate from bilateral trading to electronic platforms, there is a presumption that the rulebooks follow.  However, the transition isn’t always direct, and unique attributes can be lost.  And further adding to the complexities, a new set of market participants in the marketplace are finding their way—often without a clear understanding of traditional market structures.  We all know from experience that institutional traders and participants follow well-established rules of exchanges and the CFTC, and while a few may stray and have the book thrown at them, a presumption of compliance is entrenched.  However, as new participants and infrastructure providers gain easy access to the automated aspects of our markets, I have greater concern that in this environment— which can be game-like —active adherence to built-in limits and supervision, and constant monitoring for risky behaviors— and risk generally may not be so endemic.

To be clear, individual accountability and due diligence cannot be marginalized simply because the regulatory fit is not perfect.  This is especially so where we operate within the flexibility of a principles-based regime deeply rooted in the public rulemaking process.

I am committed to ensuring that the rise of retail participation and the exchanges, intermediaries and innovators who are eager to meet demand for products and services are appropriately brought into the regulatory fold.  Whether under the CFTC or another regulator, they must be incentivized or required to prioritize compliance and risk management.  As barriers to access recede and there may be fewer traditional intermediaries, regulators will be increasingly tasked with evaluating existing regulatory programs, architectural features, and underlying infrastructure to ensure they are fit for purpose and require responsible behavior.

We must also remain vigilant and consider how any decisions we make could apply to new and emerging risks.  And as always, whatever interpretation we pursue must not run counter to clear Congressional intent.

As such, we have included in our upcoming strategic plan a goal of encouraging innovation and enhancing the regulatory experience for market participants in the U.S. and abroad.  Strategies towards achieving this goal include: increasing stakeholder engagement; leveraging principles-based regulation towards ensuring our regulatory approach is calibrated with the risks presented; ensuring adherence to well-defined, transparent, and consistent processes; harmonizing regulations for market participants subject to concurrent CFTC and SEC jurisdiction; and addressing risks and opportunities arising from significant emerging trends in derivatives markets, including DeFi, environmental, social, and governance (ESG) investing, digital assets, and event contracts.

Re-evaluation, Rectification, and Reformation

We can never assume that our work is done.  There are always new issues to tackle and some issues that are not so new, but should have been addressed much earlier in our development.  While our priorities will always rest with our core markets, that universe is forever expanding.  We will continue to re-evaluate the reforms put in place in the wake of the financial crisis and will reconsider whether they remain fit for purpose.  We will address new and emerging issues and risks.  This cycle will continue as our goals will include strengthening the resilience and integrity of the derivatives markets while fostering their vibrancy, and doing so in a manner that promotes the interests of all Americans.

Meeting these goals includes reducing global market fragmentation while maintaining the high standards that have supported the U.S. central counterparties being among the soundest in the world, and advancing policies that deepen liquidity and increase transparency without reducing the risk-mitigating benefits of regulation.  We will continue working with our international counterparts and participating in international standard setting bodies to advance thoughtful policy and discourage the appeal of racing to the regulatory bottom in individual jurisdictions.  We will focus on keeping pace with emerging markets in the Middle East and Asia, especially as we consider the varying degrees to which there is adoption of policies relating to DeFi and crypto assets as well as ESG investing and climate-related product and markets.  As well, the markets are still adjusting to Brexit and the global transition away from LIBOR remains on course, but there is still much to be done.

Meeting these goals also includes ensuring the derivatives markets remain an effective risk management tool for end-users and addressing the unique role played by agricultural community stakeholders and smaller financial institutions and market intermediaries within the market ecosystem.  It means answering the President’s global call to tackle climate change by reinforcing the role of derivatives in confronting climate-related risks and supporting innovation that addresses these risks and supports capital allocation.  The CFTC’s mission focused on risk mitigation and price discovery puts us on the front lines as we will need to use our wide-ranging and flexible authorities to address the impact of increasingly severe and frequent weather events as well as the orderly transition to a low carbon or net zero economy.

Underlying much of this is a strategy aimed at improving the agency’s collection, use, analysis, and protection of data.  Regulators cannot afford to be awed by innovation; we need to comprehend it, and have meaningful dialogue with stakeholders.  The realization of the promise and perils of innovation within our markets requires consideration of market utility, appropriately tailored oversight, customer protections, and accountability.  At the CFTC, we are moving beyond the incubation stage.  Real applications require us to move out of the sandbox and apply a more immediate and deliberate approach across the agency, and I am looking forward to the work ahead.

We are Subject to Change for the Better

Earlier this month I was pleased to introduce the CFTC’s very first Chief Diversity Officer as one of my first announced hires.  I spent the last several years at the CFTC raising concerns regarding diversity, equity, and inclusion at the Commission.  The creation of the Chief Diversity Officer position and the reorganization of the Office of Minority and Women Inclusion (OMWI) and equal employment opportunity (EEO) functions mark the beginning of the next chapter for the CFTC.  We are at a break-through moment and we are primed for long-term structural change that I strongly believe will benefit the agency and our stakeholders.

If we are to operate as a Commission that is not only a good steward of taxpayer dollars, but is a genuine source of support for all of our valued team members, we must apply more than a band-aid to address wounds that are running deep.  I understand that the problems to be solved require substantial internal and external input over time, and that they are further complicated by the ongoing pandemic.  We are moving towards creating a more united workforce driven by strategically embracing and embedding diversity, equity, inclusion, and accessibility principles and best practices and equal opportunity into Commission culture and operations.  I simply ask for patience and a little tolerance, because while this level of change may not be completely smooth, it is most definitely necessary.

A key part of the overall strategy, and one that is close to my heart, is to ensure the CFTC is a source of future leaders.  Looking at our organizational chart, we are lacking not only diversity at our highest ranks, but we are lacking an entire population of junior staff members.  To resolve this imbalance, I am directing an agency-wide strategic approach to human capital management to better attract, develop, retain, and promote a diverse workforce whose expertise will serve as a hallmark in the derivatives industry.  As I said above in my conversation about the changing marketplace, this will require us to think, work and operate differently than we have before.  This will not be easy, but I am motivated by the challenge, and I’m excited to get to work on this.

To Be Continued…

In closing, I want to thank you again for providing me a venue to deliver my first remarks as Chairman.  Let me again remind you that there is much to come, especially as the confirmation process begins for four new CFTC Commissioners.  Accordingly, while there is much I can say about my own vision and goals and the agenda I plan to set, because of the dynamic, ever changing markets we have the privilege of stewarding, it still may be “subject to change.”

Thank you.

I want to thank the Chamber of Digital Commerce for inviting me to speak today.  Before beginning, I want to provide the standard disclaimer that the views I express today are my own and not necessarily those of the Commission I am proud to serve upon.

Do any of you have a theme song?  I have several that describe various milestones in my life, and as I reflect on my time at the CFTC, I’m leaning towards I Can Do Hard Things by Jennifer Nettles.[1]  As the song goes, “Sometimes I don’t like it, but that don’t mean I don’t love it.”  I do love my job—not in spite of, but because of, the challenging matters that we tackle (often in the face of difficult circumstances well beyond our comfort zones).

That’s where I would like to start—getting out of our comfort zones and doing hard things.  This is front of mind for me in light of the incredible innovations we are seeing these days in terms of the structure, products, and services being offered in financial markets.  Many—but by no means all—of these innovations arise from developments in financial technology such as the growth of digital assets and decentralized finance (or DeFi).

As financial markets evolve and adapt to new demands, market regulators must not stifle beneficial innovations by clinging rigidly to regulatory approaches of the past that may no longer be fit for purpose.  But by the same token, infrastructure providers who offer the market access to new, innovative services must not dismiss the fact that they may be required to seek and comply with regulatory oversight in order to assure market integrity and customer protection.  It’s time to thoughtfully consider the hard things we all must do to get comfortable with current realities.

So there, I have acknowledged the obvious, but why is this so hard?  Achieving the benefits of innovation in the context of market regulation is tougher than it sounds because we are not starting with a clean slate.  Take, for example, the U.S. derivatives markets regulated by the Commodity Futures Trading Commission.  These markets have, for some time, been characterized by futures and swaps contracts with varying degrees of execution and clearing occurring on centralized venues through intermediaries responsible for brokering and guaranteeing such transactions predominantly for institutional clients.  Recently, though, the pace of technological development and increasing retail interest in these markets is driving new business models that rely less on the traditional centralization of institutional participation via intermediaries, and rather propose to fulfil these functions in a more decentralized way.

These new market innovations are increasingly presenting novel issues that require comprehensive thinking by those of us at the CFTC who regulate the derivatives markets.  I believe that our current approach of relying primarily on enforcement actions to impose penalties on those with novel products and markets for their failure to register with the agency is simply an insufficient response.  I agree that many of the entities in question should be registered with the CFTC for oversight purposes, as we are tasked by Congress to regulate the infrastructure that permits access to swaps and futures—and many of these entities are, in fact, performing that function.  However, we must acknowledge that the infrastructure we oversee is rapidly changing—and our current regulatory regime was not designed to fit the types of services that are evolving to meet the market’s demands.

So, what’s a regulator to do—continue to take enforcement actions against companies that develop products and business models that are outside-the-box, all the while knowing that our existing rules governing the registration and regulation of the traditional market infrastructure are ill-suited to the very thing that has driven their development (i.e. an expansion in the types of participants seeking access to these products and markets, and their preference for less intermediation)?  Certainly, that is the easiest answer: “It’s not our job to tell you how to meet our rules, just figure it out.”  Wait, what?  How do we expect these companies to conform to a system that does not recognize their value add, the demands of their customers, or even perhaps the future of these markets?  What is the goal—to shut down these services, or to encourage those who deliver these services to do so under proper oversight?

I certainly hope it’s the latter.  After all, it is innovation that provides solutions to meet new market demands.  Congress has established a principles-based regime with flexibility to permit adaptation to innovation in the derivatives markets.  And welcoming innovation in those markets historically has been at the heart of what we do at the CFTC.

I believe it is thus incumbent upon the CFTC to bridge the gap between its enforcement and oversight functions by setting more clearly defined regulatory expectations for new, innovative applications in the derivatives market infrastructure.  That is a much taller task as compared to simply enforcing rules on the books beyond their original context.  It’s a tough job—but it is our job—and I am confident in our ability to do hard things.  We cannot be mere bystanders to the fundamental market changes taking place before our eyes, nor should we abdicate the responsibility Congress has given us to “promote responsible innovation and fair competition.”[2]

Adaptation by market regulators, however, should not be viewed by participants as a means to escape regulation.  Quite the contrary, our adaptation to innovation is necessitated by the responsible oversight we owe the marketplace.  As these matters continue to land on the CFTC’s enforcement docket, it is urgent that we provide direction to those who seek to comply with the law.  And then, armed with more clearly defined expectations, the CFTC can better identify those truly bad actors who seek evasion of the rules—and who deserve the full force of robust enforcement action.

In an attempt to start a helpful conversation, I have below identified a non-exhaustive list of areas in which our current rulebook governing infrastructure may require adapting to account for various new innovations taking shape in response to current market demands:

Trading Platforms (Designated Contract Markets and Swap Execution Facilities):  In its recent enforcement action against Polymarket,[3] the CFTC found that an online trading platform offering event-based binary options failed to register as a designated contract market (DCM) or swap execution facility (SEF).  To operate its markets, Polymarket deploys smart contracts, which are hosted on a blockchain.  This was a matter of first impression for the CFTC with respect to a blockchain-based trading platform.  Yet, despite this fundamental difference from the traditional DCM/SEF infrastructure for which the CFTC’s rules were written, the CFTC has not given any public consideration to how such a platform seeking to register as a DCM or SEF would be expected to operate under its existing rules.  

The term “DeFi” is often used to describe some of the protocols relevant in this framework, and some argue DeFi can exist without regulatory oversight—a topic I will leave for another day.  But in a broader sense, I believe that DeFi is spurring innovative functionalities by market infrastructure providers that may improve efficiencies for those seeking the benefit of centralized liquidity (a feature of more traditional and regulated derivatives markets). The really hard thing that requires our attention is this: How do we achieve our regulatory objectives in a manner that still enables infrastructure providers, and their customers, to benefit from these innovations?

Clearinghouses (Derivatives Clearing Organizations):  Beyond trading, difficult questions persist relative to central clearing, which is a key tenet of addressing counterparty credit risks in derivatives markets.  Our clearing rules are designed around a structure where intermediaries stand between clients and clearinghouses as guarantors, and where clients (often institutional) use leverage to increase their exposure.  But we are lately seeing many new retail-focused derivatives clearing organizations (DCOs) that do not use an intermediary model.

To date, we have accommodated this model by imposing conditions such as requiring products to be fully collateralized.  But as we begin to see requests from DCOs to offer leveraged clearing to retail market participants, we would be well-served to clearly define regulatory expectations before enforcing the application of ill-suited rules.  And we must do so in a transparent way in order to fairly encourage competition.  We are well aware that there is a need for such engagement to maintain the safety and soundness of DCOs while at the same time encouraging retail access to the clearing infrastructure.  It’s a difficult task, but we can do hard things.

Brokers and Counterparties (Futures Commission Merchants):  In its recent enforcement action against Kraken,[4] the CFTC found that an online exchange enabling customers to engage in “retail commodity transactions” in digital assets such as Bitcoin operated as an unregistered futures commission merchant (FCM) with respect to those transactions.  This finding begs the question:  If Kraken had sought to register as an FCM, how would it have been expected to operate?  The CFTC has never comprehensively addressed how retail commodity transactions are to be regulated, and many of the CFTC’s rules for traditional FCMs do not fit Kraken’s role as an exchange.[5]  As a result, we are now obligated, in my view, to explain the regulatory parameters such transactions and such non-traditional FCMs are expected to meet—yet, another hard thing the CFTC must tackle.

In conclusion, the key takeaway is that we are at a crossroads that requires everyone to roll up their sleeves and do hard things.  Derivatives infrastructure providers must recognize that while their business models may be novel, they do not operate outside of the regulatory oversight required by U.S. law under the Commodity Exchange Act.  And for its part, the CFTC must urgently consider fine-tuning its rulebook (often a hard and tedious task), because responding to technological developments and ongoing market dynamics primarily through enforcement is neither good for the marketplace nor sustainable for the agency.  We all benefit from clearly defined regulatory expectations that promote compliance and strong enforcement focused on those who blatantly disregard such expectations to the detriment of your markets.