CFTC Meeting on Clearing of Non -Deliverable Forwards and Bitcoin

Key Topics & Takeaways

  • Criteria for Clearing: CFTC Chair Massad said that as the CFTC considers whether to propose mandatory clearing for NDFs it must assess: 1) if there is sufficient liquidity to support clearing; 2) whether the necessary rules and infrastructure are in place to support clearing; and 3) the effects that clearing may have on mitigation of systemic risk as well as competition.
  • Cross-Border Discussions: Commissioner Wetjen noted that representatives from the EC are meeting with the CFTC this week to engage in discussions and come to an agreement on “equivalency within a dual registration framework” and that the number of requirements being examined is “now rather small, which is encouraging.”
  • NDF Clearing Recommendation: CFTC’s O’Keefe highlighted that the current recommendation suggests mandatory clearing for 12 currencies with tenors between three days and two years
  • Market Supportive for Clearing: Bank of England’s Bailey said data analysis shows that the market conditions and structure in Europe would be supportive of a clearing mandate.

Meeting Participants

Opening Statements

Chair Massad

Tim Massad, Chairman of the Commodity Futures Trading Commission (CFTC), said in his opening statement that as the CFTC considers whether to propose mandatory clearing for non-deliverable forwards (NDFs) it must assess: 1) if there is sufficient liquidity to support clearing; 2) whether the necessary rules and infrastructure are in place to support clearing; and 3) the effects that clearing may have on mitigation of systemic risk as well as competition.

Giving an update on discussions with European regulators, Massad noted that the European Commission (EC) has not yet recognized CFTC-registered clearing houses as being equivalent. He explained that Europe believes the CFTC should change its regulatory approach to clearing houses that are located in Europe and registered in the U.S. and that while he believes the dual registration system is not broken, the CFTC has agreed to look at “whether we can further harmonize our rules.” Massad added that he is pleased that Europe has “decided to postpone the imposition of higher capital charges” on European banks participating in U.S. markets, saying that this “threat” would have fragmented the market. He then said that dual registration has been “the foundation for the growth of the global markets” and not a source of market fragmentation.

On Bitcoin derivatives, Massad said that the CFTC’s responsibilities are ongoing and noted that “the fact that a contract exists doesn’t mean the CFTC endorses it,” thus the agency will “remain vigilant” and continue to evaluate these new contracts moving forward.

Commissioner Wetjen

Commissioner Mark Wetjen, in his statement, noted that representatives from the EC are meeting with the CFTC this week to engage in discussions and come to an agreement on “equivalency within a dual registration framework” and that the number of requirements being examined is “now rather small, which is encouraging.”

Wetjen then said that once the CFTC gets past the equivalency determinations, it can focus on a “number of areas” where international regulators can continue harmonization efforts, specifically with respect to trading platforms. He stated, “I believe we still need to pursue a more lasting framework for non-U.S. swap-execution platforms.”

On NDF clearing, Wetjen noted that the Commission will be seeking input and a written recommendation from a newly-created Foreign Exchange Markets Subcommittee before putting any proposal out for public comment. He also stated that the implementation of a clearing mandate “must be aligned with any comparable mandates overseas,” highlighting that the European Securities and Markets Authority (ESMA) recently put forth a consultation release related to NDFs that “contains differences in substance and implementation” compared to previous CFTC staff recommendations. 

On Bitcoin, Wetjen said that fluctuations in the value of the crypto-currency have created demand for a derivatives market that would allow hedging and noted that the CFTC has already been presented with a Bitcoin swap contract by a registered swap execution facility (SEF) that has already been listed for trading. He added that “any type of open-sourced, public-ledger technology seemingly could be useful in the derivatives space.”

Commissioner Bowen

Commissioner Sharon Bowen, in brief remarks, stated that clearing is a centerpiece of financial reform and a practical and common sense approach to ensuring that U.S. companies remain competitive while protecting the American public.

Panel 1 – CFTC Clearing for Non-Deliverable Forwards (NDF)

CFTC Presentation

Brian O’Keefe, Deputy Director of the CFTC’s Division of Clearing and Risk, gave a presentation on the staff’s thinking around a NDF clearing requirement and how to avoid issues that came up when clearing requirements were being created for interest rate swaps (IRS) and credit default swaps (CDS).

O’Keefe explained that foreign exchange (FX) NDFs are generally used for currencies where there are restrictions on off-shore delivery and that they are mostly settled in U.S. dollars. He said the CFTC considers the following factors when looking to create a clearing mandate: 1) levels of outstanding notional exposure; 2) availability of a rule-based framework; 3) effects on systemic risk; 4) market complexity; and 5) legal certainty in the market.

He highlighted that the current recommendation suggests mandatory clearing for 12 currencies with tenors between three days and two years. He also pointed out that of the $7.4 trillion in NDF in these currencies, 99 percent are currently un-cleared. However, he pointed out that the most recent data show that over the most recent one-month period there has been a 61 percent increase in clearing.   

ESMA Presentation

Rodrigo Buenaventura, Head of the Markets Division of ESMA, said that Europe is taking a “bottom-up” approach to the clearing of NDF, which is triggered by notification that clearing houses are authorized to clear these products. These actions are then reviewed at the ESMA level to determine if a clearing mandate is warranted. He highlighted that the ESMA consultation includes 11 currencies, which are the same as the CFTC’s recommendation minus the Peruvian Nuevo Sol.

Buenaventura said that ESMA assesses the level of standardization, availability of pricing information, and levels of liquidity when determining a clearing mandate. He said he thinks these criteria are met in the NDF space and noted that by the time this mandate is implemented, more central counterparties (CCPs) will be recognized and authorized to clear these products.

Bank of England Presentation

David Bailey, Director of Financial Market Infrastructure at the Bank of England (BoE), said that while the data on NDFs is not as extensive as IRS or CDS products, the BoE’s analysis shows that the market conditions and structure would be supportive of a clearing mandate. He noted, however, that these supportive indicators become “less strong” as maturities of the products lengthen because liquidity decreases and bid-offer spreads increase in longer-maturity products.

Panel 1 – Q&A

Benefits and Timing of Clearing Mandate

Wetjen began the discussion by asking what the benefits of clearing are to the markets and the public.

Gavin Wells, Global Head of LCH.Clearnet ForexClear, explained that market participants originally wanted to clear FX products to address counterparty credit risk issues and to mitigate settlement risk. He also noted that economic benefits can be realized due to multilateral and bilateral netting. He added that there will be greater impetus to clear once the rules for margin on un-cleared swaps takes effect and explained that the main reason market participants are clearing currently is to test the operational readiness of the system before any mandate is put in place.

Jason Vitale, Global Head of Foreign Exchange Prime Brokerage at Deutsche Bank AG, stressed the importance of ensuring that U.S. investors can access global liquidity “from day one” if a clearing mandate is put in place and that currency pairs need to be globally consistent.

Wetjen then asked if it is important to “marry up” the implementation schedules of clearing requirements in the U.S. and Europe. 

Kim Taylor, President of the CME Group, said there would be benefits to “moving in closer time alignment” but said it would be more important to ensure that there is not a situation where one jurisdiction has a trading mandate and the other does not. She said this situation would affect access to liquidity. 

Phil Weisberg, Global Head of FX Thomson Reuters FXall, expressed concern that liquidity could be bifurcated when the market moves to clearing but noted that clearing may allow new market participants, who have had difficulty accessing these products, to enter the market. 

Adam Cooper, Chief Legal Officer at Citadel, supported parallel implementation, saying it would avoid “splitting liquidity” and would facilitate competition. 

Clearing and Trading Mandates

Massad then asked what would happen if clearing mandates were not implemented at the same time and if this would create market fragmentation risk. He also asked if trading would move to other jurisdictions if a trading mandate was imposed in the U.S. but not elsewhere. 

Cooper replied that the he did not think there would be market fragmentation risk if clearing mandates were not perfectly aligned but did say that uneven application of a trading mandate would potentially create liquidity risk and market fragmentation. 

Troy Rohrbaugh, Co-Head of Global Rates, Foreign Exchange, Commodities and Emerging Markets at J.P. Morgan, said that implementing a clearing mandate simultaneously with Europe would be ideal. He then said that if the U.S. and not Europe were to impose a trading mandate it could bring in new market participants in the long run, but cautioned that it would create bifurcated liquidity in the short term. 

Wetjen said that options to address these concerns would be to: delay the clearing mandate, prevent a trading mandate from going into effect, or revisit the Commission’s approach to trading mandates. 

Supurna VedBrat, Managing Director at BlackRock, said she would like to see more liquid currency pairs included in the first phase of implementation and that it is important to have the ability to trade in the time zone and regions which have the most liquidity. She added that SEF trading should move to become more electronic and allow for more NDFs to be traded electronically. 

Buenaventura then explained that there are timing constraints in the ESMA regimes and that January 2017 is the earliest date that a trading mandate in Europe could take effect. 

Package Transactions

Wetjen then asked that kind of package transactions involve NDFs. 

Yasushi Takayama, General Counsel at Nomura Securities International, said that having a trading mandate follow a clearing mandate would create a difficult situation where NDFs would have to be executed through SEFs. 

Chris Allen, Managing Director and Global Head of Regulatory Strategy at Barclays, said that having a trading mandate apply to NDFs but not to options would create a problem for NDF delta hedges. 

Wells said that it is appropriate for NDF to be used as a delta hedge and that these packages should be kept together. He then mentioned that 90 percent of these transactions are not packages and that this issue is of “relatively small scale.” 


Wetjen next asked what is unique about NDF that would make reporting difficult. 

Jill Sigelbaum, Global Head of Foreign Exchange & Alliances at Traiana, said that she does not think reporting is an issue from a market infrastructure perspective. 

Mike Lesage, President of Risk Management at Cargill, disagreed and said there are market structure issues with rates and credit and that a lot of clients and futures commission merchants (FCMs) are not ready to report these transactions. 

Taylor stated that she has heard from customers that there is a lot of impact from new regulatory requirements such as the supplementary leverage ratio. She said that new rules are imposing more requirements on cleared products than un-cleared ones and that this works against the benefits of clearing. 

VedBrat stated that her firm wanted to voluntarily clear NDFs in January but that there were very few FCMs ready to clear these products. 

Bailey concluded the panel by saying he would like to hear more comments in the consultation response on the appropriate maturity of products for the clearing requirement. 

Panel 2 – Digital Currency Introduction – Bitcoin

Thomas Leahy, Associate Director of the CFTC’s Division of Market Oversight, explained the self-certification and draft filing of TeraExchange’s Bitcoin NDF. He noted that their derivative uses a propriety index to track the price movements of Bitcoin’s value and that these contracts are cash settled. He said that back testing their index consistently showed that Bitcoin prices in their contracts were not affected by outlier prices and that TeraExchange demonstrated an ability to monitor the underlying markets for fraud and manipulation. 

Leonard Nuara, President and Co-Founder of TeraExchange, highlighted that there are over 40,000 merchants worldwide that accept payments in Bitcoin and noted that in an average trading day, Bitcoin’s market value will change by about three percent. He said there is “great demand” for a regulated type of risk transfer solution for Bitcoin’s value in the form of swaps or futures product. 

Nuara explained that the Bitcoin NDF is an institutional level product, not available to retail customers, and that it is it bilateral, non-cleared, non-deliverable, and has collateral delivery from both sides of the trade. He also added that it is traded as a request for quote (RFQ) with the option for liquidity providers to indicate interest and that tenors range from one day to two years. 

Jerry Brito, Executive Director of Coin Center, an advocacy organization for digital currencies, explained that Bitcoin is an open source protocol which anyone can use without needing authority from any central entity.  He explained that every transaction of Bitcoins is logged in a public ledger called the “block chain” where every transfer of ownership is recorded and time stamped.  

Houman Shadab, Professor of Law, New York Law School, suggested that banking regulators and monetary authorities concerned with currencies should not be brought “into the equation” when looking at a regulatory structure for Bitcoin, because it more closely resembles a commodity than a currency. He then explained that there are types of Bitcoin derivatives that are “smart contracts” which are programmable ahead of time to pay out if certain conditions or time frames are met. He said these types of advantages can allow for better integration of markets on a global basis. He concluded that the CFTC “may want to consider exempting these types of agreements from the full scope of regulations” to balance consumer protection and market stability with the advancement of innovation.   

Tim Byun, Chief Compliance Officer of BitPay, noted that the first version of Bitcoins came out in 2009 and that adoption of the currency is still “very experimental.”  He said that while it is not currently mainstream for the public or Wall Street, it could be used for market trading purposes and an alternative class of assets for money managers. 

Panel 2 – Q&A

Commissioner Christopher Giancarlo asked for clarification on how Bitcoin is a digital commodity. 

Brito explained that Bitcoin, “at the end of the day” is a token that can be used as currency but can also be used for other purposes. 

A GMAC member asked what degree of anonymity is available in Bitcoin exchanges and what potential there is for money laundering to occur. 

Brito replied that payments are either identified or anonymous on the block chain that is publically available. He added that while some of these transactions may be anonymous, many computer science experts have suggested that “de-anonymize-ing” transactions “is a lot easier than some folks think it is. 

Another GMAC member asked if there is risk of the currency being devalued due to an increase in computing power that would “unlock” Bitcoins faster. 

Brito explained that the program for unlocking Bitcoins varies and adapts to keep the level of Bitcoins being introduced into the money supply predictable. 

Next a committee member asked how the market participants can know there is not a “back-door” to the code that would allow for fraud to take place. 

Brito explained that since the source code is open the general public, including “the world’s foremost cryptographers,” has been able to verify that such a back-door does not exist. 

Byun highlighted that Ecuador is currently looking into tying its national currency to a protocol like the one used for Bitcoin. 

Brito then concluded that regulating Bitcoin would be like trying to regulate the internet and said governments should look to regulate the behaviors and activities of the market, rather than the protocol itself. 

For more information on this meeting and to view a webcast please click here.