Oct 27, 2022 By: Turnkey Trading Partners Over the past month the commodity interest industry has been circulating rumors that CME Group may be entering into the brokerage space and launching a Futures Commission Merchant (“FCM”). This rumor was confirmed by CME on October 26, 2022. CME chairman and CEO Terry Duffy was quoted as saying: ““There has been a tremendous amount of speculation about how CME would, or would not use, an FCM but it’s important to note that nobody knows what an FCM is going to look like five, 10 or 15 years from now,” he added. “Is it going to look the same as it does today or will it look completely different?” Many Turnkey clients have contacted us and expressed they are fearful of CME’s intentions with this move. Is this fear justified? CME Group; Traditional Futures Must Remain Relevant The last part of Duffy’s comment from above is telling “Nobody knows what an FCM is going to look like in five, 10, or 15 years from now”. It is Turnkey’s view that CME’s decision was not made in a vacuum and was likely in direct response to the CFTC’s request for comment regarding LedgerX – DBA FTX US Derivatives (“FTX”) efforts to amend its DCO registration. Turnkey identified FTX petition to the CFTC as a potential risk to the industry back in May of 2022 when we published “NFA Against FTX Crypto Proposal” which readers should now revisit. In summation we observed that NFA’s arguments against the FTX proposal largely followed the approach taken when OTC Forex was trying to get off the ground. Back in May we wrote: “…The result was that a regulatory framework was developed around retail currency trading which held to the traditional concept of futures commission merchants belonging to a DSRO in order to offer non-intermediated margined derivatives products to retail customers. This decision to apply traditional futures market regulatory concepts to OTC forex nearly destroyed the US forex market. Turnkey predicted this would occur at the time when an article we authored was widely circulated in 2010 entitled “Obama Threatens Forex, Says Goodbye to OTC Gold Trading”. It appears, sadly, NFA intends to take the same approach when it comes to the FTX proposal to the CFTC.” FTX’s efforts have put traditional industry participants in a very difficult position. Should the CFTC grant the FTX request; NFA, CME Group, and other traditional players may become irrelevant. Established players are dependent upon a distributed risk clearing model. On the other hand, should the CFTC deny the FTX request they very likely would be putting a nail in the coffin of OTC Digital Currency trading and brokerage in the US. CME Group’s decision to register as an FCM suggests to Turnkey that they feel the threat from FTX is very real. Success On Merit Turnkey in general believes in free and open markets where innovation is allowed to thrive. On the other hand, as a compliance consulting firm, we also believe in appropriate, reasonable, and just regulation. The financial services industry must be permitted to evolve with technology. At the same time the space cannot become the Wild West through technology innovation avoiding existing regulation. The digital currency space needs to find a friendly ally in US regulators to ensure the market opportunity in these financial products is not lost forever like it was with OTC forex in 2010. CME, NFA, and other established industry participants must take digital currency seriously and will need to learn to compete on merit. It is Turnkey’s view that traditional commodity futures contracts will still have a place in the financial services sector. Margin based futures are important for commercial hedging. Auto liquidation via an automatic and centralized process has many questions it must answer. This approach seems highly unlikely, at least at this time, to work for traditional bona fide hedge market participants. These participants still make up a great deal of volume in the sector. Traditional commodity risk management needs the market to function as it always has. This should leave room for CME Group and other brokerage firms to thrive through proper customer service and support of our traditional industry participants. On the other hand, the FTX approach makes a lot of sense for retail day trading. It fits well with crypto currency as well as other financially settled products. This will force CME Group and others to compete for this type of business likely requiring new and more innovative technologies and product features to do so. Should You Be Nervous? Change is always scary. FTX proposal to upset the traditional commodity industry clearing and execution model will likely hurt some traditional players. It will however cause other industry participants to gain an advantage in their respective areas of expertise. Change drives innovation and moves progress forward. Inappropriate regulation does the exact opposite. The FTX proposal makes a lot of sense for products like digital currency and OTC Forex. It may not make as much sense for traditional commodity futures and options trades. Ultimately should the CFTC and NFA gain regulatory authority over the nascent crypto currency space their will be more brokerage volume than ever before. More volumes mean more opportunities for business development to support a growing population of traders and investors. Financial services industry innovation happens slowly but is inevitable. Brokers within the space should pay close attention to the political and business battle developing between FTX and CME Group. The future of the industry depends upon it.