United States: SEC And CFTC Leaders Vow To Cooperate On Virtual Currency Regulation

Last Updated: February 8 2018
Article by Jeffrey L. Robins

Most Read Contributor in United States, September 2018

Chair of the SEC Jay Clayton and Chair of the CFTC J. Christopher Giancarlo described their agencies' approaches to the regulation of virtual currency and pledged to collaborate to provide investor protection.

In testimony before the U.S. Senate Banking Committee, Mr. Giancarlo noted that some observers tout the transformative potential of distributed ledger technology, while others characterize it as overblown hype with no real utility. He emphasized the importance of perspective, saying that virtual currencies receive media attention that is disproportionate to their small market size. The novel nature of virtual currencies presents a unique set of challenges for regulators, he said. With regard to CFTC authority and oversight, Mr. Giancarlo said that the CFTC does not have regulatory jurisdiction over cash or spot transactions in virtual currency, but does have regulatory jurisdiction over derivatives on virtual currencies. He highlighted several recent efforts by the CFTC to communicate its authority over virtual currencies and enforce federal commodities regulations against bad actors in the virtual currency markets.

Mr. Giancarlo also stressed the importance of perspective when considering the impact of the exchange trading of Bitcoin futures, again emphasizing the small size of the market. He addressed concerns about the self-certification process employed by exchanges to list virtual currency futures products, and reiterated that the CFTC has developed a heightened review process to ensure that virtual currency futures were not susceptible to manipulation. In the interest of facilitating transparency, he stated, the CFTC is requesting that exchanges disclose to the CFTC which steps were taken to solicit public input with regard to particular virtual currency product listings.

Mr. Giancarlo asserted that broadening CFTC authority to include virtual currency spot markets would represent a "dramatic expansion of the CFTC's regulatory mission." Considering the retail investor-oriented nature of virtual currencies, he said that they may require closer regulatory oversight, and encouraged Congressional consideration of exploring policy solutions to facilitate more effective federal regulation of virtual currencies. He acknowledged the many potential benefits of virtual currencies and distributed ledger technology, and encouraged a "proper balance of sound policy, regulatory oversight, and private sector innovation."

SEC Chair Clayton emphasized that initial coin offerings ("ICOs") often contain the hallmarks of securities and should be subject to federal securities laws. As the virtual currency and ICO markets experience exponential growth, Mr. Clayton expressed optimism for the potential financial benefits, but stressed that retail investors deserve an appropriate degree of investor protection. He pointed to the global nature of the product, the widespread lack of regulation, and cybersecurity deficiencies as significant red flags surrounding many ICOs, and said that no ICO has registered with the SEC. Mr. Clayton underscored the risks associated with ICOs, and warned that naming conventions do not absolve ICO issuers of their SEC-registration obligations.

Mr. Clayton further stated that the SEC has not approved any exchange-trade products holding virtual currencies, and also expressed concern about trading platforms that are not federally regulated and may not afford investors with an appropriate level of protection. He emphasized that the SEC does not have direct oversight over currency or commodity transactions, including trading platforms. He highlighted SEC enforcement efforts in the virtual currency space, and vowed to take a collaborative approach with the CFTC and other regulators to oversee the virtual currency markets.

Commentary / Jeff Robins

The call for new federal regulation of cryptocurrency markets is getting stronger.  In their joint letter to the Wall Street Journal two weeks ago, the Chairmen publicly broached the topic of new federal regulation and signaled that they would be supportive of efforts to begin serious conversations about the possible substance.  In their testimony yesterday, each Chairman repeated the point to the committee, highlighting that current state regulations were not designed with securities exchange-like platforms in mind.  Giancarlo in particular signaled support for new federal regulatory oversight over such markets focusing on data reporting, capital standards, cybersecurity and measures to prevent fraud.  

Other notable highlights below.  

Chairman Clayton:

  • The Chairman is concerned that cryptocurrency trading markets have names and characteristics that give the misleading impression that they are regulated securities markets.
  • Most cryptocurrencies today are primarily speculative investment opportunities, with the utility of tokens only a secondary characteristic. Correspondingly, the ICOs the Chairman has seen "by and large" have the hallmarks of securities.
  • Clayton warned that he perceives that market intermediaries have by and large elevated form over substance in emphasizing the utility characteristics of tokens to conclude that they are not securities.
  • The SEC considers that there are a number of issues that will need to be addressed before it will permit ETFs or other investment products based on cryptocurrencies.

Chairman Giancarlo:

  • The self-certification process has generally worked well and it is the function of the exchanges to solicit stakeholder input before self-certifying new products.
  • The CFTC will require exchanges self-certifying cryptocurrency derivatives to describe the steps they have taken to solicit and obtain stakeholder input.
  • The CFTC has adequate authority to regulate and supervise the markets for which it is responsible, but does not regulate spot market trading. Expanding its responsibility to regulation of spot-market trading would be a "dramatic" expansion of its regulatory mission.
  • In the first instance, the right approach to regulating cryptocurrencies and distributed ledger technology is "do no harm." However, more regulatory oversight over spot markets is likely needed, especially to protect retail investors.

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.

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