Outgoing CFTC Chairman Giancarlo: Regulation of Futures and Blockchain Should Be Largely Led by Markets

In a speech delivered to delegates of the Commissione Nazionale per le Societa e la Borsa (CONSOB- Italy’s securities regulator), CFTC Chairman J. Christopher Giancarlo highlighted his organization’s commitment to regulating commodities markets, including the cryptocurrency sector, in a manner that gives room for innovation.

He also emphasized that markets themselves should be a primary mitigator.

According to Investopedia:

“The Commodity Futures Trading Commission (CFTC) is an independent U.S. federal agency established by the Commodity Futures Trading Commission Act of 1974… Its goals include the promotion of competitive and efficient futures markets and the protection of investors against manipulation, abusive trade practices, and fraud.”

Giancarlo began by stating that, like participants in the Italian Futurist art movement of the early 20th century, he is excited about how technology can, “…break…down the slow linear course of the past.”

Giancarlo discussed his ringside seat on the edge of the 2008 global financial crisis when he, “…serv(ed) as a senior executive of one of the world’s major trading platforms for credit default swaps (CDS), then the epicenter of systemic risk.”

He recalled how regulators struggled to measure the extent and velocity of the meltdown:

“I remember a call from a U.S. bank regulator asking about CDS trading exposure of several major banks, including Lehman Brothers.  In fact, trading conditions were deteriorating by the hour.  It was clear that the regulator had little means, short of telephone calls, to read all the danger signals that the CDS markets were broadcasting.”

…and suggested that widespread implementation of distributed ledgers (DLTs, also known as ‘blockchains’) could give regulators an unprecedented means of surveilling markets:

“Imagine if, instead of having to call around to brokerage firms like mine searching for market information, prudential regulators had access then to a ‘golden record’ of the real-time ledgers of all regulated trading participants…At a minimum, it would certainly have allowed for far faster, better-informed, and more calibrated regulatory intervention instead of the disorganized response that unfortunately ensued.”

DLTs, “…could (also) enhance efficiencies and transparency not just in our financial markets, but also across the real-economy… (and) DLT will likely develop hand-in-hand with smart contracts that can value themselves in real-time, report themselves to data repositories, automatically calculate and perform margin payments and even terminate themselves in the event of counterparty default.”

Giancarlo also cited several studies indicating that DLTs could cut costs in the administering of financial data:

In fact, one study estimates that DLT could eventually allow financial institutions to save as much as $20 billion by 2022 in infrastructure and operational costs each year. Another study reportedly estimates that the technology could cut trading settlement costs by a third, or $16 billion a year, and cut capital requirements by $120 billion…it is undeniable that DLT and interoperable database systems hold enormous commercial promise.”

For the record, there are some studies, including a two-year study conducted by Deutsche Bundesbank, which, in the words of Deutsche Bank President Dr Jens Weidman, found that, “…compared to the systems currently in use, the blockchain solutions did not fare better in every way: the process took a bit longer and resulted in relatively high computational costs…and so far the real breakthrough as application is missing,”

Giancarlo is nonetheless hopeful that DLTs will help re-orient markets that have been fragmented in the advent of digitization and help regulators maintain a handle on them:

“Consider, for example, how the digitization of everything, including music, travel, trading, and even farming have furthered the decentralization of traditional intermediaries.  Such decentralization of key economic actors is an enormous challenge to most regulatory approaches and frameworks, which tend to focus on key intermediaries through registration of major market participants and designation of self-regulatory organizations comprised of such participants.”

Regulating increasingly fragmented and digitized markets will require that regulators be technologically literate, said Giancarlo:

“…(F)rom a government perspective, how can regulators be expected to mitigate risks and formulate sound policies that foster market-enhancing innovation without requisite technology literacy?”

As such, Giancarlo said that, during his tenure, he has worked to assure that the CFTC has taken, “…affirmative steps to evolve into a 21st century regulator and craft a modern regulatory approach, ” using a formula of 4 elements:

 1. “Adopting an Exponential Growth Mindset.”

 Specifically, this means expecting rapid change not just in technological innovation, but also in market adoption and utilization of new and disruptive digital technologies.” 

2. “Creating an Internal FinTech Stakeholder.”

“The stakeholder should have both an external and internal focus.  Externally, the stakeholder engages with innovators – whether start-ups or existing market participants – and can help save them time and resources by providing feedback on new concepts or identifying regulatory friction… the stakeholder also benefits by gleaning key insights into technological change and market evolution.”

“…I am glad to say that it is the description of our very own LabCFTC.”

“LabCFTC has engaged with more than 275 entities in cities and regions around the world, including NYC, Chicago, Silicon Valley, Austin, Singapore, London, Boston, and Washington, D.C. LabCFTC has published timely primers on emerging technologies, including virtual currencies and smart contracts, embarked on an innovation competition, informed policy at the Commission, participated in numerous external events, operationalized bilateral FinTech cooperation arrangements with international regulators, and engaged with the US Congress and other governmental bodies.”

3. “Becoming a Quantitative Regulator.”

“Commercial trade execution and strategy in CFTC regulated markets is increasingly driven by quantitative data analysis of highly granular market data.  We are beginning to chart a parallel course for the CFTC to become a Quantitative Regulator, which means an effective and up-to-date big data organization capable of engaging in robust data collection, automated data analytics, and artificial intelligence deployment.  The transformation I describe here will be necessary to ensure we can glean critical market intelligence, conduct effective trade surveillance and oversight, calibrate policy prescriptions, and capably regulate our markets.”

“In many respects, this quantitative capability is the necessary antidote to systemic disintermediation.  It makes the regulator competent to conduct independent market data analysis across disparate data sources, less reliant on delegation to SROs and major market intermediaries, and a potential node capable of accessing information found in decentralized economic blockchains and networks.”

4. “Embracing Market-Based Solutions.”

“The ingredient (here) is to embrace market-based solutions – a concept that should be assumed and readily accepted but that perhaps today requires some reminders.”

 Markets… are the basis for our regulatory mandate.  In the US, market-based capital and risk transfer have allowed for unparalleled industrial and technological innovation…markets… can be more nimble than bank finance, and are more comfortable with handling intangible collateral.”

Through the interaction of hundreds, if not thousands, of individual economic actors, markets further drive price and value discovery, allow for the efficient allocation of resources, and permit risk transfer that drives stability and certainty in real-world economic activity.  While markets are not always perfect, they have proven time and again to be the most effective means humans have to drive economic productivity and prosperity.  For today’s younger generations, you can think of markets as the ultimate in crowd-sourced and decentralized decision making.”

The CFTC’s emphasis on markets is grounded in its commitment to the principles of free market capitalism, Giancarlo said:

“Indeed, that is the central value proposition of free market capitalism.  The proposition that broad and sustained prosperity generally occurs wherever in the world there are open and competitive markets, free of political interference, combined with free enterprise, personal choice, voluntary exchange and legal protection of person and property.  This value proposition is a source of human expression, aspiration and creativity.  Freedom of choice is a social good in its own right, a moral and economic imperative.”

While these tenets inform a light-touch approach at the CFTC:

“This is not to say that careful oversight, targeted enforcement, and proper guardrails are not appropriate.”
Nevertheless, “…our individual concerns or judgments should not override the availability of markets for others to make their own determinations or to pursue their own goals,” he said.

Giancarlo claimed that the “self-certification” process permitted by the CFTC, (which was used to green light Bitcoin futures at the CME and CBoe)”…has allowed for robust and dynamic risk transfer markets to develop and test new products without a time-consuming application process.  Indeed, over 12,000 new futures products have come to market in the US since 2000, far more than in any other national marketplace.

Still, more than the usual amount of consultation was done on Bitcoin futures, Giancarlo said:

“With respect to the Bitcoin products, because they were novel and based on a unique crypto-asset, the exchanges did engage in substantial prior discussions with CFTC staff before launch; this allowed for incorporation of risk mitigating elements, including around higher margin requirements and contract sizes.”

Giancarlo even suggested that, based on information from economists from the San Francisco Fed, “…(T)he launch of Bitcoin futures products coincided with the subsequent and precipitous drop in the price of Bitcoin, perhaps because futures allowed for the first accessible way to speculate against the price of the asset.”

Giancarlo has publicly stated his intent to depart the CFTC during 2019.

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