(“DCR”) of the Commodity Futures Trading Commission
(“CFTC”) issued an advisory (“05/30/23 DCO Advisory”)
relating to registered, or those seeking to register as,
derivatives clearing organizations (“DCOs”) that offer
clearing services involving contracts for digital assets. This
advisory follows DCR’s May 17, 2023 advisory to DCOs in connection with prime
brokerage (“PB”) arrangements and trading on swap
execution facilities (“SEFs”) (covered previously here).
Both advisories are short one-page documents that remind DCOs
and entities that have not been registered as DCOs to focus on
risks associated with novel business arrangements (i.e.,
PBs on SEFs and clearing for digital assets) and note that the DCR
will be “placing emphasis on potential risks … related to
system safeguards, physical settlement procedures, and conflicts of
interest.” More specifically, the 05/30/23 DCO Advisory
addresses potential conflicts of interest issues related to
DCOs’ affiliated entities and the “dual-hatted”
executives.
Concurrently with the publication of the 05/30/23 DCO Advisory,
CFTC Commissioner Kristin Johnson issued a statement encouraging the staff of the CFTC to
work on drafting a proposed federal rule to address unique issues
associated with clearing digital assets and focus on the following
four areas: “conflicts of interest arising from vertical
integration of activities and functions; custody and client asset
protection; operational and technological risk, specifically
cyber-risks; and market manipulation and fraud.” Commissioner
Johnson noted that many of these concerns were highlighted by
LedgerX DCO’s submission to the CFTC for disintermediated
clearing of contracts on digital assets, which was subsequently
withdrawn following the collapse of FTX in the fall of 2022.
As we had noted previously in connection with the CFTC’s
September 29, 2021 SEF advisory, this is a way of CFTC staff messaging
the industry that it is watching that specific conduct, it has
found deficiencies and that an enforcement action may be
forthcoming. Also, as Commissioner Johnson has alluded in her
statement, the 05/30/23 DCO Advisory could be attempting to
accomplish more than it can, and a proper federal rulemaking would
be more appropriate given that it would involve public
comments.
Further, considering that during its June 7 meeting the CFTC finalized its DCO
governance rule and has proposed the DCO winddown rule and
implemented amendments to CBOE Clear Digital, LLC order of
registration, the CFTC is looking at broad revision of its
regulatory approach to risk management generally and in connection
with DCOs specifically.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.