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Principles-based regulation has unlocked significant growth in our traditional markets and is a well-suited framework for the evolving marketplace of digital commodities.
Innovation-forward mission
The CFTC also benefits from having innovation directly in its agency mission, which explicitly requires the Commission to promote “responsible innovation” in fulfilling its core tenants of protecting customers and upholding the financial integrity of the marketplace. The CFTC has balanced these duties, without sacrificing the safety of the markets, throughout its fifty years of existence by nurturing the development of new asset classes like interest rate futures, energy contracts, volatility indices, emission allowances, over-the-counter swaps, and most recently, crypto futures products.
The listing of futures on digital commodities has already provided the CFTC with significant experience regulating the cryptocurrency markets. In 2017, the CFTC first allowed exchanges to offer futures, options and swaps based on bitcoin. This decision brought these derivatives products into the CFTC regulatory framework for the first time. Since then, the range of products has expanded to include futures and options on Ether, Solana, Stellar, Avalanche, Hedera, Cardano and Ripple.
Today, more than 60 cryptocurrency futures and options contracts trade on seven CFTC-registered exchanges. Collectively these contracts make up the world's largest fully regulated market for derivatives on cryptocurrencies and one of the primary institutional gateways to this new asset class.
This experience, along with the CFTC’s innovation-forward regulatory approach, positions the agency well for assuming more responsibility in the regulation of cash digital commodities.
Robust customer protections
Another area worth highlighting is the CFTC’s customer protection regime, which has stood the test of time in protecting customer assets during various defaults in the futures markets. This regime consists of layers of protections around the segregation of customer funds. The CFTC requires that futures commission merchants (FCMs)—those brokers who serve as agents for customers—segregate, reconcile and confirm customer balances daily while providing a guaranty against shortfalls and losses should customers default.
The regime adds another layer of protection by requiring FCMs to contribute to a “rainy day” default fund should a single FCM not be able to cover its losses. The protections also empower clearinghouses to port – or transfer – segregated customer funds from a failing FCM to a healthy one to maintain the functioning of the markets. I experienced this firsthand with the Lehman Brothers crisis and its resolution that I helped oversee during my time at the CFTC.
These customer protections have held up as recently as the 2022 collapse of FTX, in which the only solvent part of that company was its CFTC-regulated derivatives clearing organization, LedgerX.
The CFTC’s customer protection regime would benefit the cash crypto markets and provide needed safeguards for end users should Congress provide this authority to the agency.
Strong enforcement
It is also worth highlighting the CFTC’s enforcement authorities that protect investors from fraud and manipulation and deter other market participants from wrongdoing. Over the years, the agency has used its enforcement authority effectively and aggressively.
For example, the agency utilized its enforcement authority to pursue firms that attempted to rig the Libor interest rate benchmark. This led to scrutiny of benchmarks across a range of other markets, as well as a transition to more rigorous methodologies for price calculations to avoid this manipulative conduct.
The CFTC has also used this enforcement authority to protect retail customers against highly-leveraged contracts based on currencies. The CFTC has effectively brought enforcement actions against those who prey on unsophisticated investors with get-rich-quick schemes. These actions have significantly reduced the amount of foreign currency fraud in our industry and deterred others from engaging in this corrupt activity.
The CFTC has aggressively punished firms that have attempted to manipulate our energy markets. For example, during my time leading the CFTC, the agency charged several energy companies with attempting to manipulate prices for natural gas, sending strong deterrence signals to other energy firms in that space.
Given this track record, I believe the CFTC would be an effective cop on the beat for this industry.
Effective cross border approach
Lastly, I want to highlight the CFTC’s approach to cross border trading, which has allowed customers access to global risk management products without endangering the integrity of U.S. markets.
Futures markets have operated internationally for decades, with market participants in the U.S. accessing overseas markets for a wide range of commodity futures. With the global nature of commodity markets, the CFTC has developed a framework for allowing access if the overseas markets are subject to comparable regulation and supervision in their home countries.
This framework has struck the right balance between protecting US entities and customers from fraud and manipulation while providing them with access to a wide range of markets around the world. As Congress considers regulating this new asset class, it should consider the benefits of this cross border approach, given the global nature of digital commodities.
Beyond emphasizing these regulatory strengths, I would like to turn to specific stakeholder issues that would bring needed capacity and clarity for these new products.
The important role of futures commission merchants
As you consider the various models for regulating digital commodity markets, we urge you to carefully weigh the important role of intermediaries.
In the US futures markets, these are known as futures commission merchants, or FCMs. Under the futures model for regulation, they have a set of responsibilities critical to the integrity of futures markets.
Those responsibilities include preventing misconduct by their customers and assisting regulators in maintaining orderly markets and preventing fraud, abuse and market manipulation.
FCMs also are critically important to the financial stability of the clearing system as a whole. They provide the vast majority of the capital in the default funds maintained by the clearinghouses to absorb losses in case of a member default.
As of the fourth quarter of 2024, FCMs contributed 98.4% of the $34.2 billion held by the top five US clearinghouses registered with the CFTC. Without this contribution from intermediaries, I question who would provide the buffer in the event of another FTX-style collapse.
Cross product margining and cross product netting
The first issue involves the treatment of risk-reducing trades for margin and capital purposes. Like traditional markets, FIA supports digital securities supervised by the SEC and digital commodities supervised by the CFTC. These markets are highly interconnected; however, each agency has distinct margin and custody requirements for the products they regulate. Regulatory differences in margin regimes have complicated the ability to provide risk offsets that are usually available when one clearinghouse clears the same products.
Providing margin offsets when offsetting transactions are risk-reducing incentivizes prudent risk management and hedging activity in both digital and traditional markets. It also allows for margin efficiencies for participants. We support statutory language that instructs the CFTC and SEC to allow for cross margining between offsetting positions in their markets.
Additionally, we support legislative language that instructs prudential regulators to address their bank capital rules to recognize these offsetting risk positions through cross product netting. These related changes will bring important capacity to FCMs that provide client access to digital products and beyond, and it will help ensure the success of these markets.
Avoiding conflicts of interest
Another area worth highlighting is the need for clear rules around managing the conflicts of interest that arise when a single entity takes on multiple registration categories.
Traditionally, the CFTC has regulated its markets by functional registration category. Exchanges that bring together buyers and sellers must register as designated contract markets (DCMs). Clearinghouses, with their obligations to protect the financial integrity of the system, must register as designated clearing organizations (DCOs). Clearing members, those firms that guarantee and safeguard customer funds, must register as FCMs.
Given these targeted responsibilities, registrants have historically been housed in independent legal entities. Increasingly, however, we see more entities creating a “vertical stack.” In other words, these entities are combining exchanges, clearinghouses, FCMs and trading arms all within the same legal structure.
This is particularly true for entities in digital asset markets. In our May 2022 comment letter about the FTX US Derivatives application before the CFTC, FIA expressed concern that collapsing the existing multi-tiered ecosystem—with its inherent checks and balances and customer protections—could undo the strong foundation of the listed derivatives markets and, ultimately, put customers at risk.
As such, we support legislative language that requires the CFTC to conduct a rulemaking on managing conflicts of interest when these various registration categories exist in the same firm. We believe the development of consistent rules around conflicts will ensure that customers are not faced with differing customer protections due to market structure design.
Conclusion
In closing, this committee has an opportunity to ensure these important markets continue to develop in a safe and innovative way – and one that protects customers and their funds.
The time has come to enact a regulatory framework for digital assets that allow the US to lead in this asset class. I look forward to working with this committee on the best approach to reaching this important goal.
Thank you for this opportunity to testify.
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