Securities Regulation Daily CFTC actions set the stage for transformative developments in derivatives trading
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Tuesday, July 25, 2017

CFTC actions set the stage for transformative developments in derivatives trading

By Brad Rosen, J.D.

The CFTC issued an order by a unanimous 2-0 vote granting LedgerX, LLC, a New York-based institutional trading and clearing platform for digital currencies, registration as a derivatives clearing organization (DCO) under the Commodity Exchange Act (CEA). In a related action, the commission’s Division of Clearing and Risk (DCR) issued a staff letter exempting LedgerX from complying with certain Commission regulations by virtue of LedgerX’s unique fully-collateralized clearing model. LedgerX was also granted a swap execution facility (SEF) registration on July 6, 2017.

With the DCO registration order together with the related suite of approvals and relief, LedgerX has become the first federally licensed execution facility and clearing organization where derivatives contracts potentially will settle in digital currencies according to Gary DeWaal, the Katten Muchin Rosenman attorney who served as LedgerX’s lead counsel with the CFTC on these matters.

LedgerX’s activities are considered to be groundbreaking as the company intends to use the distributed ledger technology associated with Bitcoin—the Blockchain—to receive Bitcoin from and deliver Bitcoin to its members in connection with the option contracts traded on Bitcoin. LedgerX will also employ cloud-based storage to maintain many of its required books and records. Eligible participants may include registered broker dealers, banks, futures commission merchants, qualified commodity pool entities and qualified high-net-worth investors.

Attorney DeWaal also noted the historic significance of these developments observing, "[j]ust as the launch of currency futures in May 1972 represented a landmark event in the history of derivatives trading—expanding the asset classes on which derivatives were based to include financial instruments—the beginning of trading on LedgerX later this year will also be a historic milestone."

DeWaal also noted, "LedgerX will provide a real live use case of the relevant technology serving as the backbone of a functioning company. It's practice not theory. LedgerX will permit institutional users utilizing digital currencies to hedge their exposure on a facility subject to strict requirements by law and government oversight." He added, "given the volatility of many digital currencies, this will be very useful and could encourage the greater use of digital currencies in commerce."

DCR staff letter. In its staff letter, the DCR recognized that "LedgerX is a fully-collateralized DCO, meaning that a participant must provide LedgerX with collateral sufficient to cover the maximum potential loss of the contract before the trade can be executed." Stemming from this fundamental recognition, DCR provided LedgerX with the following relief from complying with Part 39 of the commission’s regulations with respect to the following:

  • engaging in monthly and daily stress testing;
  • obtaining periodic financial reports from market participants;
  • transferring positions to other FCM’s;
  • providing end of day position data so as to monitor financial risk;
  • having default procedures and rules in place; and,
  • providing information regarding the identity of certain market participants.

While the CFTC has taken an innovative and forward looking approach with respect to granting LedgerX its DCO registration and related relief, as well as embracing burgeoning distributive ledger technology, it also noted in its release "this authorization to provide clearing services for fully-collateralized digital currency swaps did not constitute or imply a Commission endorsement of the use of digital currency generally, or bitcoin specifically."

LedgerX anticipates commencing operations sometime in September, 2017.

Attorneys: Gary DeWaal (Katten Muchin Rosenman LLP) for LedgerX, LLC.

Companies: LedgerX, LLC

MainStory: TopStory CFTCNews ClearanceSettlement CommodityFutures Derivatives ExchangesMarketRegulation Swaps

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