The United States Commodity Futures Trading Commission (CFTC) has issued a staff advisory letter to registered derivatives clearing organizations (DCOs) and DCO applicants, highlighting the risks associated with expanding the scope of their activities, with a specific focus on digital assets. The CFTC Division of Clearing and Risk (DCR) emphasized the importance of identifying and mitigating new risks in the rapidly evolving digital asset market.
Identifying risks and implementing mitigation measures
In recent years, the CFTC has witnessed a growing interest among DCOs and applicants in diversifying their product offerings, business lines, clearing models, and services related to digital assets. The DCR expects these entities to actively identify potential risks and implement measures to mitigate them effectively.
One of the main areas of concern highlighted by the DCR is system safeguards. Given the heightened cyber and operational risks associated with digital assets, clearing organizations need to ensure robust system safeguards to protect against potential threats. It is crucial for DCOs to invest in advanced cybersecurity measures to safeguard against hacking attempts and other security breaches.
Additionally, the CFTC highlighted the need to address potential conflicts of interest arising from dependencies on affiliated entities or services. DCOs must establish effective governance structures to manage conflicts of interest, such as those related to dual-hatted executives and shared systems and resources. Transparency and independence are vital in maintaining the integrity of the clearing process.
Focus on physical delivery and regulatory standards
The advisory letter also discussed the concept of “physical delivery” in the context of digital assets. It refers to the transfer of ownership rights involving the movement of digital assets from one account or wallet to another. This issue aligns with the U.S. Securities and Exchange Commission’s reported plans to propose a new rule that could affect crypto firms serving as custodians for their clients’ assets. The proposal has faced criticism within the crypto sector.
Commissioner Kristin Johnson has urged the CFTC to convert this advisory into a comprehensive rule-writing effort. In her statement, she emphasized the need for parallel regulation to ensure that crypto-commodity derivatives clearing models adhere to the most rigorous regulatory standards. Johnson noted that some crypto firms, including LedgerX, have already become derivatives clearing organizations regulated by the CFTC. She highlighted the significance of establishing a rulemaking process that addresses the unique challenges of introducing customer protections in non-intermediated crypto-markets.
While the issuance of a public warning by a regulatory body often precedes regulatory actions in a particular sector, the CFTC has been actively pursuing enforcement actions against crypto companies, including recent action against Binance’s global operations.