CFTC warns clearing organizations of risks associated with digital assets

• The CFTC has issued a staff advisory letter to derivatives clearing organizations (DCOs) regarding the risks of expanding activities, specifically focusing on digital assets.
• The advisory emphasizes the importance of proactive risk management and highlights concerns related to system safeguards, conflicts of interest, and physical deliveries.
• Commissioner Kristin Johnson calls for the CFTC to initiate a formal rule-making process to establish stricter regulations for crypto-commodity derivatives clearing models.

The United States Commodity Futures Trading Commission (CFTC) has issued a staff advisory letter to registered derivatives clearing organizations (DCOs) and DCO applicants, cautioning them about the risks involved in expanding the scope of their activities. In particular, the letter highlighted the risks associated with digital assets, signaling the CFTC’s increased focus on the emerging crypto market.

Increased interest in digital assets prompts CFTC advisory

The advisory letter, released by the CFTC Division of Clearing and Risk (DCR), emphasized the importance of proactive risk management. The DCR urged DCOs and applicants to actively identify and mitigate new, evolving, or unique risks from their involvement with digital assets. This move comes in response to the growing interest among DCOs in expanding their clearing operations to include digital assets.

The CFTC’s advisory letter highlighted three key areas of concern: system safeguards, conflicts of interest, and physical deliveries. Given the heightened cyber and operational risks associated with digital assets, the CFTC stressed the need for robust system safeguards to protect against potential threats. The advisory also drew attention to potential conflicts of interest arising from dependencies on affiliated entities or services within the DCOs.

Commissioner calls for formal rule-making effort

Furthermore, the advisory touched upon the concept of “physical delivery” in the context of digital assets. The CFTC referred to the transfer of ownership rights, emphasizing the importance of secure and reliable processes for transferring digital assets between accounts or wallets. This concern aligns with the U.S. Securities and Exchange Commission’s reported plans to propose a new rule to regulate custodial services offered by crypto firms, a proposal that has faced criticism within the crypto sector.

The CFTC’s advisory has garnered attention from industry participants and experts. Alexander Grieve, vice president of communications firm Tiger Hill Partners, noted that Bitnomial, derivatives clearing organization, has a pending application with the CFTC. Additionally, LedgerX, recently acquired by MIAX from FTX, operates as a CFTC-regulated clearinghouse, subjecting it to the regulator’s guidelines.

In response to the advisory, Commissioner Kristin Johnson called for the CFTC to take further action and transform the advisory into a formal rule-making effort. Also, Johnson highlighted the need for rigorous regulatory standards to be applied to crypto-commodity derivatives clearing models. She expressed concern that these models may not be subject to the most robust regulatory oversight without parallel regulation.

It is worth noting that when regulators issue public warnings about specific activities, it often precedes subsequent regulatory actions or sanctions within that sector. In recent months, the CFTC has been actively pursuing enforcement actions against crypto companies, including a notable action against Binance‘s global operations.

As the CFTC sharpens its focus on the risks associated with digital assets and clearing activities, market participants will need to adapt to the evolving regulatory landscape. The call for stricter regulations in the crypto space highlights the growing need to establish comprehensive customer protections and ensure the integrity of non-intermediated crypto markets. The industry awaits further developments as the CFTC contemplates its next steps in formal rule-making to address the unique challenges posed by digital assets.