CFTC Technology Advisory Committee Meeting

Commodity Futures Trading Commission

Technology Advisory Committee (TAC)

Friday, October 5, 2018

Opening Remarks

Commissioner Brian Quintenz

Quintenz began by recapping the February TAC meeting and introducing the four subcommittee presentations scheduled for today’s meeting. In previewing the Automated and Modern Trading presentation, Quintenz reiterated his hope that the TAC could assist the Commission in understanding whether exchanges and market participants are following best practices with respect to automated and algorithmic trading, and whether regulation can play a constructive role in alleviating risks associated with market participants failing to follow those best practices. Quintenz noted that the TAC’s next full meeting will likely be in January 2019.

Virtual Currencies Subcommittee Presentation & Digital Asset Security Discussion

Gary DeWaal of Katten Muchin Rosenman LLP explained that the subcommittee is dealing with two issues: 1) how to look at the derivatives markets and leverage characteristics, standards, and best practices to enhance the integrity and degree of trust in the underlying spot markets; and 2) whether crypto assets are a security, and what guidance the subcommittee could provide the CFTC to help with this distinction.

Richard Gorelick of DRW Holdings explained that virtual currencies, or digital assets, offer “great promise” to economies by enhancing efficiency, privacy, and trust; boosting economic growth; and fostering new economic value, noting the need to think about how to boost the integrity and quality of the markets for digital assets. He gave an overview of the spot markets and how useful and “exciting” they are but noted there is also concern due to a lack of transparency, venue risks, conflicts of interest, bad behaviors, supervision and surveillance, and anti-money laundering (AML)/know your customer (KYC). Gorelick then discussed solutions to address the concerns raised.

Andre McGregor of TLDR Capital discussed why custody regulations are important and custody limitations, to include the lack of codified regulations specific to the crypto market, limited standards and best practices, and insurance coverage.

In response to a question about how hard it is to create a new crypto currency, Alex Stein of Two Sigma Investments LP explained that a crypto currency can be created in minutes, but the adoption will not happen unless people want it. Brad Levy of IHS Markit added that crypto currencies can easily acquire other services, so there must be an important differentiation of using them as cash to acquire goods and being a store of value or asset. DeWaal noted that tokens are being used by fraudsters and that laws are being written out of a desire to eliminate the fraudsters, but that this will impede blockchain development in the future and that while binary legal decisions appear right at the time, they may not be workable for those using them legitimately.

In response to a question about whether the scope of regulation is extending beyond trading to include aspects like mining, where there could be manipulation, DeWaal explained that mining is typically carved out from application.

CFTC Chairman Chris Giancarlo asked why the policy stakes are so high for such a small market, to which Gorelick responded that while it is a small market, there is a lot of enthusiasm behind it and growth ahead of it, so now is the time to focus on a policy response to ensure the right safety and soundness guards are in place. CFTC Commissioner Dan Berkovitz replied that he looks forward to the recommendations the subcommittee presents them.

When asked if there will come a time when crypto currencies are jointly regulated by the CFTC and Securities and Exchange Commission (SEC), DeWaal replied that there is not a mechanism for joint regulation yet, and that without a compromise by law, it is considered either a commodity or a security. Gorelick added that something could start off as a security and then later become a commodity (or vice versa), and that it could pose interesting questions regarding at what point does the jurisdiction change. Levy added that global banking regulators will also play a role in this in the long run.

Automated and Modern Trading Markets Subcommittee Presentation

The subcommittee presentation was delivered by Bryan Durkin of the CME Group and was focused on the results of the upcoming release of an FIA Survey of Market Integrity Tools, as well as the principles outlined in the IOSCO Consultation on mechanisms used by trading venues to manage extreme volatility and preserving orderly trading. The subcommittee supported the conclusion of the IOSCO Consultation that given rapid and highly complex trading, a principles-based approach to regulating automated trading is necessary to quickly and effectively adapt to changes in trading behavior and capacity. As for next steps, the subcommittee will consider reviewing the mechanisms outlined in the IOSCO Consultation, listing out potential principles (including what they are, what do they apply to, and what market participants do they apply to), provide the TAC a short update of what caused the 2010 “Flash Crash,” and changes that have been made since.

RegTech and Robo-Rulebooks

JoAnn Barefoot of Barefoot Innovation Group gave an overview of key concepts for RegTech, including: 1) aim for actual transformation of the regulatory space; 2) the need for institutional readiness and capacity; 3) learn to move faster; 3) the need for new architecture and models; 4) the need for more collaboration; 5) regulators must have the capacity for experimentation; 6) work to interoperability by setting standards to get everyone on the same framework; 7) move toward an open-source design in regulation; and 8) introduce these changes in an alternative regulatory track rather than attempting to reform the whole system at once.

Pierre Lamy of Regnosys suggested there would be value for market participants and regulators to explore how to leverage Rosetta to make regulations easier to adopt and comply with. He noted that the technical infrastructure already exists and is being tested in the marketplace. Brijesh Solanki of Credit Suisse explained that the challenge is understanding how to structure the process steps that are involved and how to organize the execution of the rules. He continued that “a lot more work needs to be done” because “we are not there,” and that while there are a lot of challenges, there are also a lot of opportunities with these technologies.

Brian Trackman of LabCFTC gave an overview of the LabCFTC Prize Competition and the comments they received from their Request for Input, including strong support for CFTC-sponsored FinTech competitions, with the first one being early next year. He continued that key takeaways included: 1) a global interest in the Robo Rulebook concept; 2) automated regulatory reporting can provide greater market visibility; 3) focus on practical steps; and 4) the importance of standards.

There was a discussion about the need for establishing a common language and data model to help achieve global regulatory consistency. CFTC Chairman Chris Giancarlo stressed his commitment to working with other regulatory agencies around the globe, noting that yesterday a cooperation agreement was signed with Australia, the third of its kind.

Distributed Ledger Technology and Market Infrastructure Subcommittee Presentation

Brad Levy of IHS Markit explained that distributed ledger technology (DLT) is broad, will apply to all industries and is a “massive game changer” where data and applications can be distributed and used safely, cautioning that unintended consequences will have to be worked through. He discussed some of the operational, technology, regulatory and legal concerns with DLT, as well as some of the risks of introducing this new technology to clearinghouses. Levy then discussed how DLT will rely on cryptography, combining current technology with new technology, taking existing technology and replacing it with DLT, and taking current technology and tweaking it for new instruments.

Erik Barry of Credit Suisse stated that the promise of DLT is a “wonderful” opportunity to solve all the issues that futures commission merchants (FCMs) come across on the clearing side of the business. He listed potential FCM benefits from DLT, to include: 1) initial clearing record of executed trade; 2) post-trade services via consistent application programming interface (API); and 3) expanded access and connectivity opportunities. He then discussed critical considerations to maximize FCM and end-user benefits and challenges on DLT adoption.

Levy noted that next steps for the subcommittee include: 1) refining the focus on the functional areas and “drill down” on those; 2) push deeper into technology areas (Blockchain, cryptography, etc.); and 3) specific industry efforts for adopting this technology.

CFTC Commissioner Dawn Stump noted that there has been a struggle with bringing in the data in a standard way under current rules and asked what it will take to drive such standardization. Levy replied that there are multiple standards defining transactions, but that some markets lack adoption of those standards or lack technology, but that the standards are there.

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