House Committee on Agriculture: For the Purpose of Receiving Testimony from the Honorable Rostin Behnam, Chairman, Commodity Futures Trading Commission
House Committee on Agriculture
For the Purpose of Receiving Testimony from the Honorable Rostin Behnam, Chairman, Commodity Futures Trading Commission
Wednesday, March 6, 2024
Topline
- Republicans expressed concerns over Basel III’s impact on the derivatives market.
- Members from both parties discussed the FIT for the 21st Century Act and the need to develop a regulatory framework for digital assets.
Witnesses
- The Honorable Rostin Behnam, Chairman, Commodity Futures Trading Commission
Opening Statements
Agriculture Chair G.T. Thompson (R-Pa.)
In his opening statement, Thompson noted that under Behnam’s leadership, the CFTC has tackled a robust rule making agenda. He said he appreciated the CFTC’s commitment to providing effective oversight of the derivates markets, especially through its transparent public rule making and advisory committee processes. Thompson discussed his concerns that the Basel III Endgame proposal could adversely affect commodity derivative markets, resulting in increased costs and reduced hedging opportunities. He noted the Agriculture Committee has been actively engaged in creating a much-needed regulatory framework that protects consumers, investors, and fosters American leadership in the digital asset space. Thompson acknowledged that the CFTC has not been reauthorized since 2008 and said he and Ranking Member Scott remain committed to reauthorizing the CFTC and providing it with the tools and authorities it needs to successfully execute its responsibilities.
Agriculture Ranking Member David Scott (D-Ga.)
In his opening statement, Scott emphasized his commitment to reauthorizing the CFTC and ensuring the Commission has the proper amount of funding. He discussed he and Austin Scott’s bipartisan fight against the European Union when they wanted to take over control of the CFTC and noted that Congress did not let that happen. Scott said he looked forward to hearing about what kind of damage is coming in the next ten years.
Testimony
The Honorable Rostin Behnam, Chairman, Commodity Futures Trading Commission
In his testimony, Behnam said the derivatives market plays a key role in the predictability of prices that impact the daily lives of all Americans. He explained that technology is having a larger impact on the CFTC’s jurisdictional markets than ever before. Behnam discussed the shift to structures driven by technology, which combines or compresses what were historically unique and separate activities into fewer or single activities. He noted this compression raises important questions about issues including the conflict of interest, the strength of capital margin and segregation requirements, the role of self-regulatory organizations, affiliate risk management, and most importantly, consumer protections.
Behnam emphasized how active the CFTC has been in the digital asset space. He noted that in FY2023, the Commission brought 47 actions involving conduct related to digital commodities. Behnam discussed the challenges that cyber risk presents in the digital asset space. He said that under his direction, the Commission voted to issue a notice of proposed rulemaking to require futures commission merchants, swap dealers, and major swap participants to establish an operational resilience framework and adopt non-binding commission guidance related to the management of risks stemming from third-party relationships.
Behnam said AI is another topic presenting numerous challenges and discussed the CFTC’s creation of an AI task force to develop a forward-looking AI culture. He noted that in December, the Commission proposed guidance regarding the listing of voluntary carbon credit derivatives contracts. Behnam concluded that the CFTC’s collective goal is to keep U.S. derivative markets the safest, strongest, and most effective in the world.
Question & Answer
Basel III Endgame
Thompson discussed the potential negative impacts of the Basel III Endgame and the GSIB surcharges. He cited Behnam’s comments that CFTC staff is looking at the proposals to determine if the changes would harm end user’s ability to hedge risks in the commodity derivatives market. Behnam said they have seen a huge reduction in the capability to clear and execute transactions for all market participants and that there has been a concentration in the largest 5 clearing members. He noted the CFTC is seeing huge growth in markets and the concentration of the largest five clearing members. Behnam noted that regulators need to be careful with how Basel III is implemented and ensure the continued incentivization of clearing. He said that we need to think about all constituents including farmers, ranchers, energy producers, etc. to ensure the integrity and accessibility of the derivatives market.
Rep. Austin Scott (R-Ga.) asked Behnam if he was consulted prior to the Basel III rules being proposed by the bank regulators, and if he helped with any analysis. Behnam said the CFTC was not consulted when the rule was being drafted but he has proactively been reaching out after seeing what the impacts could be.
Austin Scott asked whether Benham was aware that a mutual insurance carrier would be treated differently than a stock carrier. Benham said that he was not aware, but he said that we would think that there should be equity in the way that they are treated.
Rep. Tracey Mann (R-Kans.) asked Behnam about his concerns with Basel III. Behnam emphasized the need to ensure continued access to futures markets and an incentive to clear. He said that his intention is to put together a team of experts to inform the other regulators of what they are seeing.
Rep. Frank Lucas (R-Okla.) asked if Behnam would be willing to assist the Fed in examining how Basel III would impact the derivative market and end users. He also asked if the CFTC was asked to offer feedback. Behnam said he would be willing to share his concerns around the shifting market environment such as fewer FCMs and less services for agricultural producers and to ensure the incentivization of clearing.
Lucas asked how Basel III would impact the willingness of banks to clear derivatives for end users, and if Behnam would commit to working with the Fed to fix it. Behnam explained that the clearing business has very tight margins and noted that a number of clearing businesses have left the market. He warned that concentration is growing and emphasized the need to incentivize clearing.
Rep. Zach Nunn (R-Iowa) warned that futures commodities market consolidation is occurring at alarming rates, and asked how Basel III would exacerbate the issue. Behnam warned that this could be a significant issue, citing the existence of huge barriers to entry. He explained that he did not want to see the continued pattern consolidation and urged the incentivization of clearing.
Digital Assets & Decentralized Finance
Nunn noted that he is a proud supporter of the Financial Innovation and Technology (FIT) for the 21st Century Act. He asked if Behnam still believed that Ether falls into the commodity definition. Behnam said yes.
Nunn asked what the CFTC can do to provide clarity until the FIT for the 21st Century Act becomes law. Behnam explained that it comes down to the contracts listed on the exchange, and noted the CFTC works closely with fellow regulators.
Thompson asked Behnam about Prometheum’s plans to custody an asset that the CFTC and the SEC considered to be a commodity. Behnam noted the CFTC has listed Ether futures contracts for a number of years. He said he has not been in contact with Prometheum but the CFTC wants to be deliberate in any steps they make.
Rep. Nikki Budzinski (D-Ill.) said the joint rule-making requirement for the FIT for the 21st Century Act poses a number of implementation concerns. She asked if Congress should move forward with a bill that addresses only the CFTC’s expanded regulatory authority needs and what the timeframe of implementation would look like. Behnam said Congress needs to act to fill the existing regulatory gap, especially around Bitcoin. He said he is confident the CFTC can implement a regulatory structure within 12 months.
Rep. John Duarte (R-Calif.) asked about the primary requirements for a commodity to be eligible when listed on the Chicago Board of Trade. Behnam explained that it has to be a commodity, which has a broad definition. Duarte asked if there are documents that list the criteria, and if Bitcoin and Ethereum met the criteria when they were listed. Behnam said no different steps were taken when listing Bitcoin or Ethereum.
Duarte asked if the CFTC considered the diversity of producers and sellers. Behnam said yes, explaining that the exchange would never list a contract they know will not succeed. Duarte asked if any commodities failed to be qualified for listing on the exchange. Behnam said he didn’t think so.
Duarte asked about cryptocurrencies, what is being sold, and what satisfies the commodity criteria. Behnam explained that in the cash market, the interpretation is that it is not a physical commodity but also not a security. He added that because it’s a non-security, it’s treated as a commodity.
Duarte asked whether anything that cannot be categorized as a security can be listed as a commodity.
Behnam explained that the share of the company that is issued to investors to raise capital is a security, while the product itself is likely a commodity. Duarte said we are shoehorning and giving crypto legitimacy it doesn’t deserve. Behnam agreed that we are shoehorning to an extent and said the issue demands legislative change, but he disagreed on the issue of legitimacy.
Rep. Nick Langworthy (R-N.Y.) asked what the CFTC can do to ensure that the U.S retains a high-quality workforce in the digital asset market. Behnam urged Congress to move legislation to fill gaps that will move the industry forward. He emphasized that clear regulation at the state and federal level is a critical component of any business.
Rep. Darren Soto (D-Fla.) asked how critical the FIT for the 21st Century Act is to the CFTC’s mission.
Behnam said that it is critical and discussed the need to develop a regulatory framework. He emphasized that last year, 49% of the CFTC’s enforcement docket was related to crypto.
Rep. Kat Cammack (R-Fla.) asked Behnam about any planned or ongoing rule making regarding decentralized finance. Behnam said the CFTC is engaged with market stakeholders and is considering how to engage. He noted the DeFi space presents many enforcement issues.
Cammack said she is wary of government overregulation and asked which regulatory challenges Behnam predicted for overseeing blockchain. Behnam said he did think adoption was deep enough to require the CFTC to write rules. He clarified that there might be components of blockchain that require policy. Cammack asked if any cross-border cooperation was underway, and Behnam said yes.
Derivatives & the Futures Market
Lucas asked Behnam about the importance of protections in the Dodd-Frank Act for firms that use derivatives hedging. Behnam said commercial end users are very much prioritized in Dodd-Frank, and advocated for that treatment to remain the same as we think about policy going forward.
Rep. Don Davis (D-N.C.) asked how the CFTC is utilizing tools and strategies to identify and prevent potential price manipulation in the futures market, particularly concerning agriculture commodities. Behnam said that is at the core of what the CFTC does. He explained they are working closely with the exchanges and have a regulatory framework that ensures that contracts are free from fraud and manipulation.
Thompson asked about the CFTC’s proposed rule that would establish minimum fitness standards and conflict of interest rules for derivative exchanges. He asked Behnam to elaborate on the rule. Behnam discussed the emergence of vertical integration, which raises unique and novel questions around conflicts of interest and affiliations. He explained the CFTC is looking to propose a rule on this later in the year.
Thompson asked what powers the Commission has to engage with a registered market participant regarding a transfer of ownership of a registered entity. Behnam said the CFTC’s authority is to ensure that the new combined entity remains in compliance with the Commodity Exchange Act and emphasized that the Commission cannot impose itself on merger and acquisitions activity.
Thompson said he is concerned about vertical integration situations. Behnam noted those are very new issues, and discussed the increase in the number of applicants and registrants who want to see vertically integrated stacks. He also discussed the issue with existing entitles who are registered with the CFTC and have a vertically integrated structure. Behnam explained there is nothing in the Commodity Exchange Act that would allow the CFTC to prohibit or prevent entities from combining into a single parent.
Austin Scott asked whether Benham is supportive of Federal Reserve deposit accounts for all CFTC regulated clearing houses. Benham said that he thinks that master accounts at the Federal Reserve would provide a sense of security. He says that the huge growth of markets has concentrated risk in clearing houses. He said that 62% of customer money is in the largest 5 clearing houses.
Austin Scott asked what end user concerns are that he knows. Benham said that there has a been a reduction of FCMs, and the ones that are leaving are the smaller FCMs that offer services to smaller customers. He said that we need to ensure diversity of FCMs so that all companies, small and large, can access derivative markets.
Reauthorization of the CFTC and Appropriations
Ranking Member Scott asked why it would be dangerous not to reauthorize the CFTC. Behnam said it’s important to show the investing public and our international partners that Congress takes derivative markets and U.S. supremacy in derivative markets very seriously. He said that the CFTC has not been reauthorized in 16 years and he thinks the lack of reauthorization sends a bad signal.
Scott asked what the lack of funding and appropriations means for the CFTC. Benham said that the costs are going up for a lot of things such as services, infrastructure, salaries, etc. He said that they are continuing to complete their mission with confidence but looking towards the future they will be pulled in a lot of different directions and will need to pay to acquire expertise.
CFTC Proposed Guidance on the Listing of Voluntary Carbon Credit Derivative Contracts
Rep. Alma Adams (D-N.C.) asked Behnam to explain the justification for issuance of the proposed guidance regarding the listing of voluntary carbon credit derivative contracts. Behnam explained that there are listed futures on voluntary carbon credits on registered exchanges. He said this provides the CFTC with an interest in ensuring that the underlying market is healthy, and that the contracts listed on our exchanges are free from fraud and manipulation.
Rep. Randy Feenstra (R-Iowa) asked what the CFTC is doing to ensure that farmers and landowners are being protected from fraud and manipulation in the voluntary carbon credit market. Behnam discussed the CFTC’s close work with the agriculture community as they crafted the guidance. He explained how the guidance is an effort to clarify expected diligence that the registered exchange would use.
Rep. Doug LaMalfa (R-Calif.) asked if it’s appropriate for the CFTC to be getting out ahead of the carbon credit and rare minerals market without development of the markets or Congressional approval. Behnam explained that the CFTC already has listed contracts on voluntary carbon credits. LaMalfa asked about the nature of the carbon credits. Behnam said the CFTC has futures contracts that reference an underlying registry that issues the credits themselves.
LaMalfa asked about the target goal of carbon for the guidance. Behnam explained that the intent is not to set the amount of carbon that is pulled from the atmosphere and clarified that the guidance is an attempt to ask the exchanges who list the carbon derivatives contract to use appropriate diligence when they reference underlying registries.
Quantum Computing & Artificial Intelligence
Rep. John Rose (R-Tenn.) asked how the CFTC is preparing to address the challenges of potential disruptions of quantum computing in derivative markets. Behnam noted that Quantum and AI are related in many respects. He explained that there will be benefits, but there also will be the disruption of markets and cyber and data risks. Behnam also discussed the CFTC’s issuance of a request for information from market participants to see how they are using this technology.
Rose asked if the CFTC has sufficient resources to stay abreast of the rapidly changing environment with AI and quantum computing. Behnam said consistency and certainty are important, and noted that AI, cybersecurity, and IT infrastructure are going to drive large costs in the future.
Rep. David Rouzer (R-N.C.) asked if the CFTC could partner with the private sector to better understand the risks of AI. Behnam said the CFTC is trying to engage and collect information before they act. He noted they have an Office of Technology and Innovation, which is willing to engage with the industry and understand what is happening in the financial ecosystem. Behnam said there are legal limitations to the CFTC’s ability to provide a sandbox environment.
Rep. Greg Casar (D-Texas) said he was concerned that it would be premature to pass the FIT for the 21st Century Act if we do not know what decentralization means or how to define it. He asked if Behnam had implementation concerns. Behnam said structurally, there are very clear rules about what conduct is or is not permissible.
Casar cited Behnam’s remarks that half of the CFTC’s enforcement docket was related to crypto, and said he was concerned that implementing the FIT Act would lead to more problems. He said he is concerned that giving the CFTC more authority over crypto may be setting the CFTC and American people up for failure. Behnam said that he appreciates the concern and the CFTC’s number one priority is always the traditional commodity market. He said that the market has demonstrated that there is real persistent demand from Americans to invest in crypto and warned that it’s unregulated. He emphasized the need to act to quickly and said that there is so much fraud out there and that is why it is consuming so much of their resources.
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