IATP submitted the following letter submitted to the Commodity Futures Trading Commission in response to the FTX Request for Amended DCO Registration Order on May 11, 2022.
Dear Chairman Behnam,
The Institute for Agriculture and Trade Policy (“IATP”)i appreciates the opportunity to comment on the FTX Request and to respond to a few questions in the CFTC’s request for comment about the FTX application. IATP looks forward to learning from experts at the CFTC staff roundtable on May 25 about their views on the broader topic of fully automated and collateralized Derivatives Clearing Organizations (DCOs) without intermediation by futures commission merchants (FCM).ii
IATP’s interest in the FTX request
The FTX Request, if approved by the Commission, will set a precedent for fully automated clearing and position liquidation without going through the rulemaking process. Furthermore, if approved, the FTX Request would set a precedent for the market participant’s option to post initial and maintenance margin in cryptocurrencies.
IATP understands automated clearing to be a business model extension of hyper-speed computing in Automated Trading Systems (ATS). IATP first commented to the CFTC on a Notice of Proposed Rulemaking for ATS in 2013.iii We continued to comment on the ATS rulemaking until August 2020,iv when the Commission adopted, in our view, not an enforceable ATS rule, but “Electronic Trading Risk Principles.”v One of our concerns about de facto exchange regulated ATS was expressed by agriculture futures intermediaries at two conferences, co-organized by the CFTC in 2018 and 2019. To paraphrase, but nearly quote: “What do I care if the [ATS] transaction costs are lower when I can’t find positions to lay off risk?” Those positions had already been taken by fully automated non-commercial traders endowed with hyper-speed computers located cheek by jowl with the exchanges.vi
The asset classes of the FTX DCO transactions to be cleared are currently cryptocurrencies in the spot and futures markets. However, as detailed below, FTX, through its acquisition of LedgerX, has a license to apply fully automated clearing to “all commodity classes.” FTX does not contemplate automated clearing and position liquidation, as necessary, of agriculture futures transactions. However, its investment in both carbon emissions offset contracts and Carbon Dioxide Removal (CDR) technologies indicate to us that the first non-crypto asset to be traded by FTX US Derivatives is likely to be CDR offset futures.vii
IATP has written and advocated policy about emissions offset credits and offset futures, sometimes sporadically, since 1997. Most recently, in response to an Energy and Environmental Market Advisory Committee meeting on the global expansion of offset futures trading, IATP co-authored a September 2021 letter that urged the CFTC to issue a Request for Information and a staff study on the integrity of the underlying assets of emissions offset futures contracts and the certification of those contracts by exchanges.viii
Introduction and Summary Recommendations
As a public interest group, IATP provides context for the public in regulatory matters that are already well known to the Commission and to market participants. The policy and regulatory context of the FTX Request overlaps with a debate between the Securities and Exchange Commission (SEC) and cryptocurrency trading platforms that present themselves to the investing public as exchanges but refuse to be registered as exchanges and comply with SEC rules for exchanges. The SEC points to a fundamental conflict of interest between the crypto trading platform as the custodian of client assets and as a frequent market maker, taking the opposite side of trades with those clients in contracts listed on the exchange. The SEC is considering how to prevent such conflicts of interest between the crypto exchange as custodian and as market maker to protect investors.ix The SEC has issued staff guidance to the unregulated cryptocurrency trading platforms advising them to classify their holdings of client funds to be liabilities on the platforms’ balance sheets. The guidance would create a more level playing field in trading and accounting between regulated exchanges with relatively low-risk holdings and unregulated platforms holding cryptocurrencies that are widely regarded as high risk and price volatile investments.x
As the SEC has begun to consider how to regulate cryptocurrencies and cryptocurrency exchanges, an industry with a historical antipathy to regulation is now lobbying for regulation by the CFTC and oversight by Senate and House agriculture committees with scant experience in authorizing the regulation of cryptocurrencies and their trading in futures markets.xi (Whether the previous Commission resolved the SEC identified conflict of interest prior to granting licenses for cryptocurrency futures trading and clearing is a topic for separate discussion.) During February 9 testimony to the Senate agriculture committee, FTX co-founder and CEO Sam Bankman-Fried stated,
Prior to its [LedgerX] acquisition [by FTX in 2021,xii this business was the first crypto-native platform issued a DCO license by the CFTC in 2017, which was a milestone for the agency and the digital-asset industry. That license was later amended in 2019 to permit the clearing of futures contracts on all commodity classes and not just digital assets.xiii (our emphasis)
The amendment the Commission is asked to approve builds on the 2017 license and 2019 amendment. If the Commission approves the FTC Request, it will allow FTX to fully automate margining, liquidation and re-margining of client positions to clear (and trade) “futures contracts on all commodity classes, not just digital assets.” Approval will allow FTX clients the option to post initial and maintenance margin in cryptocurrencies for transactions in “all commodity classes.” As the Commission deliberates whether to approve the FTX Request, it must consider the possibility of the fully automated trading and clearing of not just current FTX listed cryptocurrency products but of future FTX certified products in non-crypto asset classes. Such new products might include lithium futures, rare earth futures, bio-based jet fuel futures, carbon dioxide removal (CDR) futures — as noted above, FTX is beginning to invest in purportedly permanent CDR technologiesxiv — and perhaps even subsets of existing contracts, e.g., “climate smart” yellow corn or “carbon neutral” oil futures.
In the following comment, IATP considers only the impacts on investors and market structure of the FTX proposal to unilaterally transfer all credit risk to FTX customers in the clearing of cryptocurrency futures contracts traded on the FTX US Derivatives platform. However, the Commission, due to the FTX DCO license and 2019 amendment, must also consider the impacts of fully automated clearing and position liquidation on market structure and on customers trading in “all commodity classes.”
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