The Commodity Futures Trading Commission (CFTC) recently approved two applications from LedgerX – a platform for trading and clearing Bitcoin options – to become registered as a swap execution facility (SEF) and derivatives clearing organization (DCO). These approvals make LedgerX the first DCO and the second SEF approved to facilitate digital currency-related derivatives activity (another SEF, TeraExchange, lists cash-settled forward contracts on Bitcoin). LedgerX received temporary registration as a SEF nearly two years ago.
Although the CFTC authorized LedgerX to clear various types of digital currencies, LedgerX will initially only clear options on Bitcoin, which is expected to commence in September 2017. LedgerX is expected to list options on other digital currencies, such as Ethereum, in the future.
As a registered SEF and DCO, LedgerX is authorized to facilitate the execution of and act as a central counterparty for clearing swaps based on digital currencies. However, LedgerX will only be able to clear fully collateralized swaps, meaning that LedgerX must hold, at all times, funds sufficient to cover the maximum possible loss a counterparty could incur upon liquidation or expiration of the contract. LedgerX will therefore require participants to deposit at LedgerX or an approved depository sufficient collateral to cover the participant’s maximum potential loss or delivery obligation (which can be in the form of US dollars or the relevant virtual currency).
Because of LedgerX’s fully collateralized model, the CFTC exempted the clearinghouse (under CFTC Regulation 140.99(a)(1)) from certain requirements otherwise applicable to DCOs. For example, the CFTC exempted LedgerX from:
- Financial resources
- the requirement to stress test its financial resources on a monthly basis.
- the requirement for DCOs to have financial resources sufficiently liquid on hand to enable the DCO to fulfill its obligations as a central counterparty during a one-day settlement cycle.
- Product and participant eligibility
- the requirement to obtain from its non-FCM participants periodic financial reports since their fully collateralized trades would not present a credit or default risk to LedgerX.
- Risk management
- the requirement to conduct stress testing on a daily basis with respect to each large trader who poses significant risk to a clearing member or the DCO.
- Treatment of funds
- the requirement to promptly transfer all or a portion of a customer’s portfolio of positions and related funds at the same time from one FCM to another without having to close out and re-book those positions (however, this exemption is only applicable so long as LedgerX has no FCM participants – meaning its participants are not clearing on behalf of customers).
- Daily reporting
- certain daily reporting obligations, including the requirement to submit a daily report to the CFTC regarding daily variation margin payments and mark-to-market amounts collected and paid.
- Public information
- the requirement to make a public disclosure of its margin-setting methodology and a list of its participants.
Regulation of digital currencies generally
In its order granting LedgerX’s DCO registration, the CFTC stated that its approval “does not constitute or imply a Commission endorsement of the use of digital currency generally, or bitcoin specifically.” This statement reflects the developing regulatory landscape for digital currencies and derivatives on digital currencies. Some of the notable regulatory developments regarding the treatment of digital currencies are:
- In 2015, the CFTC determined that Bitcoin and other virtual currencies are “properly defined as commodities” for purposes of the Commodity Exchange Act. Our blog post on that order can be accessed here.
- In April 2017, the Securities and Exchange Commission (SEC) denied proposals to list and trade shares of two Bitcoin trust exchanges, finding that the proposals did not satisfy SEC requirements that (1) the exchange must have surveillance-sharing agreements with significant markets for trading the underlying commodity (i.e., Bitcoin) or derivatives on that commodity and (2) those markets must be regulated. Our post on those actions can be accessed here.
- In May 2017, the CFTC created LabCFTC, an initiative to make the CFTC more accessible to FinTech innovators, and to serve as a platform to inform the CFTC’s understanding of new technologies.
- On July 25, 2017, the SEC issued an investigative report concluding that DAO Tokens, a type of digital currency offered for sale by an organization using distributed ledger technology, were in fact “securities,” and that the offer and sale of those securities is subject to federal securities laws. These offers and sales of digital currencies are commonly referred to as “Initial Coin Offerings” or “Token Sales.” Our blog post on the SEC’s investigative report can be accessed here.
Click here to access the Norton Rose Fulbright Knowledge webpage on “FinTech law and regulation: blockchains, distributed ledgers, smart contracts and cryptocurrencies.”