By: Turnkey Trading Partners

On May 11, 2022 NFA responded to the CFTC’s request for comment on LedgerX – DBA FTX US Derivatives (“FTX”) efforts to amend its DCO registration.  FTX has proposed to the CFTC that it would clear non-intermediated margined derivatives products for both retail and institutional participants. The request by FTX may be the start to a new chapter for digital asset and cryptocurrency regulation within the United States.

For the last 40 years, National Futures Association (“NFA”) has worked closely with the CFTC to safeguard the integrity of the derivatives markets and protect investors. With regard to crypto currency products, Turnkey has observed while supporting our clients that NFA seems to be taking a position that is very similar to its approach when regulating over-the-counter spot forex. Those looking for breadcrumbs in how the US may ultimately regulate digital assets at the federal level should pay particular attention to the following from NFA’s comment letter to the CFTC:

“Prior to the CFTC Reauthorization Act of 2008 (2008 Act), although the CEA permitted (and continues to permit) firms registered as FCMs to act as counterparties to forex transactions with retail customers, several federal courts created legal uncertainty as to the CFTC’s jurisdiction over these transactions by holding that these transactions were spot transactions.³ Importantly, after these court decisions the CFTC did not have anti-fraud authority over these retail transactions (and never had regulatory authority), which left NFA to adopt customer protection and financial rules (approved by the CFTC) to regulate our FCM Members’ retail forex activities.

The CFTC and NFA recognized that the CFTC should have anti-fraud and regulatory jurisdiction over retail forex contracts—even if they were spot leveraged transactions—and other non-forex leveraged retail commodity transactions. We also recognized that these firms’ activities—offering trading platforms in which the firms act as counterparties to retail trades; soliciting customers via websites and solicitors; accepting customer funds and security deposits to margin trades; and auto-liquidating trades falling below the required security deposit maintenance level—did not fit within an FCM’s agency-based customer activities, and therefore the CEA’s FCM definition was not appropriate for firms engaging primarily in retail forex activities.”

Readers may recall when forex contracts were first regulated by the CFTC and NFA Congress supported NFA’s position from above. 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.

NFA provided strong insight into this line of thinking when they wrote:

“FTX states that its model should be permitted because the definition of DCO does not require it to mutualize risk among intermediaries. FTX’s observation regarding the DCO definition may be correct but its resulting conclusion that this omission allows a DCO to engage in FCM activities is not supported by the current regulatory framework.⁷ Congress specifically requires persons engaging in certain activities to register as FCMs. The omission of these activities in other CFTC registration definitions does not mean that persons are permitted to substitute one Congressionally defined CFTC registration category (e.g., DCO or DCM) for another (e.g., FCM)…

…In this case, based on the information available, FTX (through its DCM and DCO registrations) plans to offer retail customers⁹ an app or web-based platform, will presumably use advertising to solicit accounts, will accept funds for margin and will accept orders for trades. These activities fall squarely within the CEA’s FCM definition under Section 1a(28) of the CEA. The CEA requires a person engaged in those activities to be registered as an FCM under CEA Section 4d.”

Sadly, although NFA claims to support change and market innovation, the above approach was disastrous for over-the-counter forex.  In fact, the approach championed by NFA for forex regulation quite literally destroyed an entire industry in the United States.  While federal regulatory oversight within the digital asset space is sorely needed, NFA’s comment letter should concern industry participants.  Turnkey hopes that both the CFTC and NFA will reconsider this approach to regulating crypto currency and other non-intermediated market structures.  NFA is correct in its assessment that innovation in financial markets will happen. This time around lets hope the United States does not get left behind.

Click the following link to read all of NFA’s comment letter to the CFTC regarding the FTX proposal.