On February 23, 2016, the Commodity Futures Trading Commission’s (“CFTC”) Technology Advisory Committee (“TAC”) convened its first public meeting of the new year. The meeting included three panel discussions focused on nascent technological issues facing the derivatives industry. In the first panel, the TAC provided feedback to the CFTC on its proposed regulatory framework for automated trading, known as “Regulation AT.” The second panel considered ways to ensure greater consistency in swap data reporting. Finally, the third panel discussed the utilization of “blockchain” technologies in the derivatives market.
I. Panel 1: Regulation AT
On November 24, 2015, the CFTC proposed a new regulatory regime for automated trading (“Proposed Regulation AT”) and the comment period closes on March 17, 2016.1 As the comment period for Proposed Regulation AT draws to a close, market participants have had an opportunity to thoroughly examine the comprehensive regulatory framework premised on new registration and risk control requirements.2 The first panel discussion of the TAC meeting included a discussion of industry concerns about the proposed regulatory regime.
The panel took issue with the costly burdens imposed upon the marketplace by the proposed rulemaking. Panelists echoed concerns voiced by Commissioner Giancarlo last November about the requirement that market participants maintain source code repositories that must be available for inspection by the CFTC or the Department of Justice for any reason. The panel said that regulators should be required to show reasonable cause and obtain a subpoena as a prerequisite to inspecting firms’ valuable intellectual property. Industry is concerned that an obligation to provide sensitive commercial information to the government could result in leaks to foreign governments or rival firms. Panelists also advocated closer coordination between the Securities Exchange Commission and the CFTC because automated trading activity may cross products and markets. Furthermore, the CFTC should coordinate with self-regulatory organizations to prevent issues such as the National Futures Association’s (“NFA”) enforcement responsibilities conflicting with that of an exchange.
In its opening remarks, the Division of Market Oversight (“DMO”) highlighted the importance of getting the definitions within the regulation right because they determine whether a market participant is required to register with the NFA. Interestingly, the TAC panelists proposed mandating that all electronic trading firms implement risk controls. Panelists also argued that the regulation should be prophylactic and not be premised on narrow definitions that will require regular upkeep to track rapid technological changes.
When Chairman Massad asked the group to comment on the risk controls themselves, the panelists expressed a consensus that the risk control provisions are “not too far off” from being favorable. However, the panelists indicated concern related to the burdensomeness of the annual certification requirement.
II. Panel 2: Swap Data Reporting
In the second panel, the TAC members discussed ways to improve the quality of swap data reporting, with an emphasis on data consistency. In his opening remarks, Commissioner Giancarlo noted that the CFTC “still does not have accurate visibility into global swaps counterparty exposure” due to a lack of standardization. DMO proposed reestablishing the Data Standardization Subcommittee, and the TAC members agreed that the subcommittee was a good idea. Industry requested that the CFTC provide more feedback related to how swap data is being used because that information will drive their reporting. The TAC agreed that reestablishing the Data Standardization Subcommittee will address most of these issues.
III. Panel 3: Blockchain Technology
The third panel was dedicated to the use of blockchain technology in derivatives markets and included the demonstration of a swap transaction using a blockchain platform. The blockchain is a distributed ledger technology that facilitates transactions with reduced intermediation by third-parties. When two parties enter into a contract on a blockchain-based platform, the transaction is recorded in a public ledger that is distributed to all “nodes” on the network. Regulators and other market participants, as nodes on the network, would receive this data instantaneously. Collateral would be allocated amongst counterparties in real time using automated software in sync with the blockchain platform. As a result, blockchain technology could evolve ultimately to supplement or potentially replace swap data repositories and clearinghouses. The TAC noted that industry standards are lacking due to the nascent nature of this technology and it will be at least a few years before it becomes mainstream. However, as proven in the demonstration, blockchain technologies provide an alternative vehicle for transacting financial products about which the CFTC will continue to be cognizant.3
More information on the TAC meeting is available on the CFTC’s website at:http://www.cftc.gov/PressRoom/Events/opaevent_tac022316