FTX billionaire Sam Bankman-Fried seeks CFTC roundtable knighthood

Last Wednesday, the Commodity Futures Trade Commission (CFTC) convened a gathering of financial industry figures to discuss “disintermediation,” a key topic contained in a license amendment proposal sent by crypto exchange FTX.US to the US futures regulator back in March.

Despite the banal term, the consequences of this encounter weigh heavily. If approved, the proposal would allow FTX.US – and firms holding a similar Designated Clearing Organization (DCO) license – to offer crypto derivatives margin trading to retail clients without the involvement required of commodity trading firms (FCMs) – i.e. disintermediation. The latter are the futures market counterparts of securities brokers, and they are the ones who would be “disintermediated” or removed from the middle.

FTX, which started in 2019 as a derivatives-focused crypto exchange, caters to an active, professional trading audience that already trades futures contracts on its Bahamas-based unit without intermediaries. However, small US-based customers who need to use FTX.US cannot use this service.

Key players

The event was chaired by CFTC Chairman Rostin Behnam and attended by a full 5-member commission, with Senior Policy Advisor Steigerwald acting as spokesperson for the regulator.

The list of attendees included FTX CEO Sam Bankman-Fried, Neil Constable of Fidelity, Thomas Sexton of the National Futures Association (NFA), major advocacy groups including the Futures Industry Association, representatives of exchanges like Chris Edmonds of Intercontinental Exchange (ICE) and Sean Downey of the CME Group, large trading companies like Citadel and DRW, asset manager BlackRock, Chicago-based FCM great RJ O’Brien and banks with major futures like JPMorgan, Goldman Sachs and Citi.

Key context

The United States had previously not prioritized federal legislation to govern crypto trading, especially at the retail level. This omission has led to turf wars among regulators. Crypto derivatives are a particularly tricky issue because the SEC claims all tokens it considers securities, while the CFTC would oversee derivative contracts based on them. So far, bitcoin and ether are the only two assets that are considered commodities, which leaves a lot of room for debate and interpretation. For his part, CFTC Chairman Rostin Behnam expressed to Congress earlier in the year his desire to regulate both crypto derivatives and cash markets if he had the funds to do so. It can be up to Congress to make a decision.

On this point, the House Agriculture Committee hosted its own review of the FTX.US proposal two weeks ago, where five CEOs interacted with the 25-plus member agriculture committee in a heated debate. with important exchanges between Bankman-Fried and the CME. Group CEO Terry Duffy and where committee chairman David Scott (D-GA) telegraphed his views to CFTC chairman Benham ahead of last week’s meeting.

Key points of the debate

There were voices that expressed caution and more time to consider the proposal, but as the day progressed the nature of the comments seemed more consistent with the key aspects of the proposal in what could be considered as an auspicious sign when the matter comes to a vote before CFTC commissioners. before the end of summer.

Some of the questions discussed by industry experts included:

  • Who ends up holding the bag? Both competing clearing models have a “cascade” of capital that kicks in during times of very high market turbulence and limited liquidity. The makeup of these models varies widely, with the current system dependent on pooled losses and reserve capital from some 61 firms known as futures commodity merchants (FCMs). Pooled loss is a concept that shares losses if an exchange needs capital because the margin to support a trade becomes insufficient. Conversely, FCMs would be optional under the FTX.US model and Institutional Clearing Members would not be required to participate in a pooled loss situation, as traders’ positions would be marked to market every few seconds and not once a day.
  • Send money Muy Pronto. Most of the traditional exchanges and FCMs in the room were keen to point out the difference in how the current model allows FCMs to use their balance sheet to give customers credit and time to post more collateral in cases where they are approaching a margin call threshold. The FTX.US model is more automated, which means that trades “automatically liquidate” if there is insufficient margin. Here, traders are responsible for keeping track of the required margin, keeping in mind the need for collateral that might develop while the client is sleeping or on weekends. Bankman-Fried and others acknowledged that while the new model was less convenient, it tackled risk more quickly and stabilized capital for all market participants. They noted that extending credit to margin-strapped participants – as FCMs currently do – could be more costly for all participants if prices start to move in a direction where losses keep increasing. No one knows for sure if prices will return to where they were before the sharp drop. One such incident forced the London Metal Exchange to cancel trades under the traditional netting model in March, illustrating what could go wrong if losing positions were allowed to build.
  • Market access. A number of companies have expressed their openness to having access to various risk models so that the current one, which is centered around a very large futures exchange and seven bank-owned FCMs, can see more competition significant. Fidelity’s Neil Constable said his employer is literally interested in the retail investor, and with that in mind, thinking about how to democratize access to financial products for them, “this kind of proposition means we want be very committed to trying to get this into the hands of our customers,” along with the right amount of education, disclosure, and transparency.
  • Who will control these exchanges? Thomas Sexton of the National Futures Association (NFA) said the regulations don’t quite fit that model yet. He added: “We have spent a lot of time talking about compensation and our focus is retail consumer protection. It is fundamental that we have protection in place for these participants, including: how sales solicitations begin, how customer funds are protected, risk disclosures provided, customer funds and operational funds during bankruptcy from a company. He concluded with a still unclear point on the proposal of who will regulate compliance by these entities with extended licenses: “Are we really going to let this entity govern and oversee its interface with participants who are retail customers? and cautioned that if there is no independent self-regulatory body (SRO, like the NFA), it is up to CFTC staff to do so.

Key points to remember

CME Group expressed earlier this month that it is not per se against a disintermediated model and joined Intercontinental Exchange (ICE) and Cboe in suggesting that the CFTC should delay any approvals so that FTX.US does not have not what they see as an unfair advantage that leaves the company a leg up on the competition. A delay, however, could unfairly delay – perhaps for months or even years – a well-researched proposal built on moving parts for which there are precedents in the CFTC universe. A full committee vote on the measure is expected this summer.

Prospects and implications

The fact that top industry captains showed up at this one-day event signals the momentous change that is likely to occur because of it, and not just the introduction of crypto regulation and commerce. in the USA. The National Futures Association, the police arm of the CFTC, will likely become the regulator of FTX.US and other crypto exchanges dealing directly with retail customers.

The behavior of FCMs, which transfer their capital from one model to another, will prove to be decisive for the compensation model that will prevail. Bankman-Fried made several unsubtle invitations for FCMs to fall under his proposed model, creating a more capital-rich hybrid model than his company’s original request.

The ball is now in the CFTC’s court, and now that it has heard from industry and Congress, it can deliberate and make the necessary changes. If the CFTC approves the FTX.US proposal as we expect, retail investors have reason to be optimistic that the CFTC’s involvement in the crypto markets is solid and long-term. This seal of approval will lend the necessary credibility and robustness to a scrappy and promising asset class that needs it. With more crypto trading ashore, crypto projects will get more capital — retail and institutional — but these entrepreneurs will have to button up and do things they haven’t been strong in the past, like crossing their t and dart their eyes from a regulatory and governance perspective.

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