FTX billionaire Sam Bankman-Fried seeks knighthood at CFTC roundtable

CFTC Roundtable on Disintermediation, May 25, 2022.

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Last Wednesday, the Commodity Futures Trade Commission (CFTC) hosted a meeting of senior financial industry figures to discuss “disintermediation,” a key issue included in a license change proposal passed by crypto exchange FTX.US to the US -Futures regulator was sent back in March.

Despite the banal-sounding term, the consequences of this meeting are great. If approved, the proposal would allow FTX.US — and firms with a similar Designated Clearing Organization (DCO) license — to trade margin crypto derivatives for retail clients without the required involvement of futures commodity traders (FCMs) – ie disintermediation. The latter are the broker-dealers’ counterparts in the securities futures markets, and they are the ones who would be “disintermediated” or taken out of the middle.

FTX, which launched in 2019 as a derivatives-focused crypto exchange, caters to an active and professional trading audience that already trades futures on its Bahamas-based unit with no intermediaries. However, smaller US-based customers who need to use FTX.US cannot use this service.

key figures

The event was chaired by CFTC Chairman Rostin Behnam and was supported by a 5-member full commission, with Senior Policy Advisor Steigerwald serving as the regulator’s voice.

Those in attendance included Sam Bankman-Fried, CEO of FTX, Neil Constable of Fidelity, Thomas Sexton of the National Futures Association (NFA), major stakeholders including the Futures Industry Association, representatives from exchanges such as Chris Edmonds and Intercontinental Exchange (ICE) . Sean Downey of CME Group, big traders like Citadel and DRW, money manager BlackRock, big Chicago-based FCM RJ O’Brien and banks with big futures companies like JPMorgan, Goldman Sachs and Citi.

key background

The US has not previously prioritized federal legislation to regulate crypto trading, particularly at the retail level. This oversight has led to turf wars between regulators. Crypto derivatives are a particularly tricky topic as the SEC is entitled to any tokens it considers to be securities, while the CFTC would oversee derivative contracts based on them. So far, bitcoin and ether are the only two assets that qualify as commodities, leaving a lot of room for debate and interpretation. For his part, CFTC Chairman Rostin Behnam expressed to Congress earlier this year his desire to regulate both the crypto derivatives and cash markets if he were given the means to do so. Congress may make a decision.

On that point, the House Agriculture Committee hosted its own review of the FTX.US proposal two weeks ago, with five CEOs interacting with the 25-plus member Ag Committee in a lively debate with prominent exchanges between Bankman-Fried and the CME The Group CEO Terry Duffy and committee chairman David Scott (D-GA) cabled his views to CFTC Chairman Benham ahead of last week’s meeting.

CFTC Roundtable on Disintermediation, May 25, 2022. FTX CEO Sam Bankman-Fried, Neil of Fidelity … [+] police officer

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key points of the debate

There were voices calling for caution and more time to consider the proposal, but throughout the day the nature of the comments appeared to be consistent with key aspects of the proposal, which could be seen as an auspicious sign if the matter comes before the CFTC -Commissioners to vote before the summer is over.

Some of the topics discussed by industry experts were:

• Who holds the bag at the end? Both competing clearing models have a capital cascade that kicks in during times of very severe market turbulence and limited liquidity. The composition of these models varies widely, with the current system depending on mutual losses and standby capital from about 61 firms called Futures Commodity Merchants (FCMs). Mutualized loss is a concept that shares losses when an exchange needs capital because margin becomes insufficient to support a trade. Conversely, under the FTX.US model, FCMs would be optional and institutional clearing members would not be forced to participate in a shared loss situation as trader positions would be marked to market every few seconds rather than once a day.
• Send money very soon. Most traditional exchanges and FCMs in the space are emphasizing the difference in how the current model allows FCMs to use their balance sheet to give customers credit and time to post more collateral as they near a margin-call threshold . The FTX.US model is more automated, meaning that trades are “automatically liquidated” when margin is insufficient. Here, traders are responsible for keeping an eye on the margin required, taking into account the need for collateral that might develop while the client is sleeping or on the weekend. Bankman-Fried and others acknowledged that while the new model was less convenient, it managed risk more quickly and brought stability to the capital of all market participants. They found that lending to tight-margin participants – as FCMs are currently doing – could be more costly for all participants if prices trend in a direction where losses are getting bigger. No one knows for sure if prices will return to what they were before they fell sharply. Such an incident forced the London Metal Exchange to cancel trades under the traditional clearing model back in March, illustrating what could go wrong if losing positions are allowed to build up.
• market access. A number of firms have expressed openness to accessing different risk models so that the current model, which focuses on a very large futures exchange and seven bank-owned FCMs, can see more significant competition. Fidelity’s Neil Constable said his employer literally cares about the retail investor, and considering how to democratize access to financial products for them, “this type of proposal means we’re very committed to trying to do that put this in the hands of our customers,” along with the right level of education, disclosure and transparency.
• Who monitors this exchange? Thomas Sexton of the National Futures Association (NFA) explained that the regulations don’t quite fit this model yet. He added: “We have spent a lot of time talking about clearing and our focus is on retail consumer protection. It is fundamental that we have protections in place for these participants, including: how sales requests begin, how client funds are protected, risk disclosures, client and operating funds during a company’s insolvency.” will regulate compliance by these companies with extended licenses: “Are we really going to let this company govern and oversee its interfaces with subscribers who are retail customers?” and warned that if there isn’t an independent self-regulatory organization (SRO, like the NFA) is the responsibility of the CFTC staff.

The central theses

Expressing earlier this month that it is not opposed to a disintermediary model per se, CME Group has aligned itself with Intercontinental Exchange (ICE) and Cboe in proposing that the CFTC should delay any approval so that FTX.US does not has what they consider to be an unfair advantage The company has an edge over the competition. However, a delay could unfairly hold up a well-researched proposal based on moving parts, for which there are precedents within the CFTC universe — possibly for months or even years. A full Commission vote on the measure is expected this summer.

Outlook and Impact

The fact that senior industry captains have turned up for this all-day event signals the momentous shift this is likely to bring, and not just usher in crypto regulation and trade in the United States. The National Futures Association, the CFTC’s law enforcement arm, is likely to become the regulator of FTX.US and other crypto exchanges that deal directly with retail customers.

The behavior of FCMs moving their capital from one model to another will prove crucial in determining which clearing model will prevail. Bankman-Fried made several non-subtle invitations to FCMs to join his proposed model, creating a hybrid model more capitalized than that in his firm’s original application.

The ball is now in the hands of the CFTC, and after listening to industry and Congress, it can deliberate and make the necessary changes. Should the CFTC approve FTX.US’ proposal as expected, retail investors have reason to be optimistic that CFTC exposure to crypto markets is a strong plus for the long-term. This seal of approval will give a questionable, promising asset class the credibility and robustness it needs. As more crypto trade is brought onshore, crypto projects will receive 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 z and governance perspective.