At the FIA and SIFMA AMG Asset Management Derivatives Forum 2021, CFTC Commissioner Dan M. Berkovitz raised concerns regarding the legality of decentralized finance. He also described how the CFTC can support the transition to a carbon-neutral economy and highlighted recent agency regulatory developments.

Mr. Berkovitz asserted that unlicensed decentralized finance ("DeFi") derivatives markets are a "bad idea." He explained that the structure of a pure "peer-to-peer" DeFi system is intended to cut out financial intermediaries that are a source of strength to the U.S. financial markets because of the "critical financial services" they provide and the legal accountability imposed on them. He stated it would be "untenable" to allow DeFi - an unregulated, unlicensed derivatives market - to compete with a fully regulated and licensed derivatives market that is subject to the obligations, restrictions and costs of regulation.

Mr. Berkovitz also questioned the legality of DeFi markets, which are not registered as designated contract markets or swap execution facilities, even though the CEA does not except from registration digital currencies, blockchains or smart contracts. Mr. Berkovitz called on the CFTC and other regulators to (i) focus more on DeFi to prevent it from becoming an unregulated "shadow market" in direct competition with regulated markets and (ii) "address regulatory violations appropriately."

With regard to climate change, Mr. Berkovitz reiterated three principal ways in which the CFTC should support the transition to a carbon-neutral economy: by (i) securing the integrity of the primary, secondary and derivative carbon markets, (ii) collaborating with exchanges and market participants to promote new products that would allow companies to hedge their climate-related risks, and (iii) ensuring the management and disclosure of climate-related risks.

Further, Mr. Berkovitz highlighted the following CFTC regulatory developments:

  • Thresholds for the real-time reporting of block trades. Mr. Berkovitz stated that he continues to support the amendments to the real-time public reporting requirementsmade in November 2020, which increased the block size threshold at which swaps would benefit from delays in trade reporting. Mr. Berkovitz acknowledged concerns expressed by market participants that the shorter periods for trade reporting blocks may negatively impact liquidity and increase costs, inviting them to send data and analyses to the CFTC.
  • Central counterparty ("CCP") transparency and governance. Mr. Berkovitz emphasized that, with the increased reliance on derivative clearing organizations ("DCOs") since the 2008 financial crisis, the CFTC must continue to ensure transparency into DCOs' rules and procedures, as well as to ensure that, during times of financial stress, DCOs have in place (i) appropriate governance structures to manage risk and (ii) appropriate procedures for equitably allocating losses.
  • The adequacy of CCP margin requirements. Mr. Berkovitz stated that CCPs "generally performed as designed" during the COVID-19 pandemic. He also cited a recent CFTC interim staff reportthat found no "conclusive evidence" that changes in aggregate initial margin flows were "excessively procyclical" in the cleared derivatives markets at the onset of the pandemic, despite FIA assertions to the contrary. However, Mr. Berkovitz noted, the CFTC should continue to examine not only the FIA and ISDA analyses, but also the reviews conducted by (i) other national and international organizations, and (ii) the CCPs and other market participants.

Primary Sources

  1. CFTC Interim Staff Report on the Cleared Derivatives Markets: March - April 2020
  2. CFTC Statement, Dan M. Berkovitz: Keynote Address before FIA and SIFMA AMG, Asset Management Derivatives Forum 2021 - Climate Change and Decentralized Finance; New Challenges for the CFTC

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