CFTC TAC Meeting

Commodities Futures Trading Comission

Technical Advisory Committee Public Meeting

Wednesday, February 14, 2018

Key Topics & Takeaways

  • Blockchain and the Potential Application of Distributed Ledger Technology to the Derivatives Market: The first panel covered a discussion of blockchain and related distributed ledger initiatives, and their potential impact on capital markets infrastructure and regulatory reporting. The panelists, who consisted of regulators and technology practitioners, discussed the benefits of wider adoption of distributed ledger technology (“DLT”), including improved regulation and greater access to market data.
  • Market and Regulatory Developments with Virtual Currencies and Related Futures Products: The second session featured a blend of academics, regulators and practitioners who gave their insight into virtual currencies, related futures products, and market and regulatory developments and challenges. The discussion covered the asset classification of cryptocurrencies, concerns regarding market manipulation and challenges with settlement mechanisms.
  • The Future of Machine Learning, Artificial Intelligence, and Computing Power: The third session featured a presentation focused on advances in machine learning, artificial intelligence, and computing power and what kind of current and future impact they will have on markets, market participants and regulators. The panelist acknowledged that the biggest barrier to adoption of artificial technology using data to educate that is concurrently highly protected and sensitive.
  • Developments and Challenges with Automated Trading Technologies: The fourth panel featured practitioners and academics in a discussion of developments, challenges, and risks around automated trading technologies, and potential areas for regulatory consideration. Participants on the panel generally agreed that automated trading technology can provide new opportunities but that market participants must be mindful of emerging risks.
  • Cybersecurity Developments and Best Practices: The final panel of the day covered a discussion regarding emerging trends and best practices in cybersecurity. Both panelists mentioned the importance of cybersecurity resiliency and how we must utilize current technology to match the evolving nature of cyber threats.

Speakers

  • Commissioner Brian Quintenz
  • Chairman J. Christopher Giancarlo
  • Commissioner Rostin Behnam
  • Daniel Gorfine, TAC Acting Chair/Designated Federal Officer and Director, LabCFTC
  • Jennifer Peve, Managing Director Business Development, Office of FinTech Strategy, DTCC
  • Charley Cooper, Managing Director, R3
  • Dan Bucsa, Deputy Director, DMO, CFTC
  • Jerry Brito, Executive Director, Coin Center
  • Gary DeWaal, Special Counsel, Katten Muchin Rosenman LLP
  • Richard Gorelick, Head of Market Structure, RGM Advisors, DRW
  • Amir Zaidi, Director, DMO, CFT
  • Tim Estes, President and Founder, Digital Reasoning
  • Larry Tabb, Founder and Chief Executive Officer, TABB Group
  • Bryan Durkin, President, CME Group
  • Yesha Yadav, Professor of Law, Vanderbilt University and Special Government Employee (SGE), CFTC
  • Naeem Musa, Deputy Director, ODT, CFTC
  • Phyllis Schneck, Managing Director and Global Leader of Cyber Solutions, Promontory Financial Group / IBM

Opening Statement

In his opening statement, Commissioner Quintenz noted that subcommittees may need to be formed to enable the kind of focused review and thoughtful consideration needed to make recommendations in these financial technology topic areas. Quintenz cautioned that the CFTC should not attempt to make value judgements about which new products are valuable and which are not. He noted that the market, investors and consumers need to decide this for themselves. Chairman Giancarlo followed to discuss the transformative impact that FinTech can have on trading, markets and the entire global financial system. He also discussed LabCFTC’s work to keep pace with technological innovation and  to enhance the market and fair competition to the public benefit. Commissioner Behnam concluded by encouraging a dialogue between the CFTC and stakeholders in order to ensure tailored oversight and customer protections while also ensuring accountability.

Session One

Blockchain and the Potential Application of Distributed Ledger Technology to the Derivatives Market

The first panel covered a discussion of blockchain and related distributed ledger initiatives, and their potential impact on capital markets infrastructure and regulatory reporting.

Jennifer Peve began the panel by explaining the transformative changes that DLT can bring to the industry. She called for continued collaboration across industry organizations, technology providers, market participants, regulators and policy makers in order to develop best practices for technology innovation. Peve used the example of DTCC’s Trade Information Warehouse (“TIW”) of how DLT can be used to operationalize the technology on a business with appropriate meaningful scale, while also mitigating risk and driving cost efficiency for market participants. She concluded with a recommendation for promoting common global data standards and interoperability.

Charley Cooper began his speech by noting the large impact blockchain and DLT could have in the financial sector. He noted that his company R3 is exploring regulatory reporting on a distributive ledger. Rather than making wholesale transitions overnight, companies will progress the model through focusing on a specific asset class. Cooper ended in an appeal to regulators and LabCFTC, noting that if DLT was built and leveraged appropriately, it can make regulators more effective.

Dan Busca discussed how the CFTC needs to take the time to evaluate the costs and benefits of DLT and whether it makes reporting more accurate, cheaper and easier. He elaborated how the future of oversight must involve DLT as it continues to improve and mature. He did caution, however, about the costly nature of adapting a system to meet regulations. He called for the CFTC to stay technology neutral, requiring formats comply with principles without prescribing how they’re met. Ultimately, he concluded that the TAC would need to develop a long-term technology plan, including a determination of how to allocate funds to rebuild infrastructure to take advantage of DLT and FinTech as a mechanism of the future. He also noted three key advantages of DLT:

  • Better regulation through technology
  • Sharing of data and greater access via DLT
  • Reporting via blockchain

Session Two

Market and Regulatory Developments with Virtual Currencies and Related Futures Products

The second session featured a blend of academics, regulators and practitioners who gave their insight into virtual currencies, related futures products, and market and regulatory developments and challenges.

Jerry Brito began the panel by addressing the technological developments with cryptocurrencies. He noted that there are now 1,500 cryptocurrencies in existence, explaining just how much this market has grown. He also used Ethereum as an example, noting that cryptocurrency launched only two and a half years ago but now has 20 percent of the cryptocurrency market cap. He did, however, acknowledge that privacy and fungibility are two features of cash that bitcoin is currently missing. Brito addressed the challenges in processing, in particular how networks can scale to accommodate thousands of transactions per second that would be necessary for global adoption. He concluded by discussing several policy considerations, including how a state by state regime in bit licenses isn’t practical due to a lake of market provisions.

Gary DeWaal opened his discussion with the debate of whether cryptocurrency is a security or commodity.  He continued in discussing the conflict presented by the validity of decentralized ledgers with the desire of centralizing some cryptocurrency transactions. DeWaal concluded with asking the CFTC for clarification on whether cryptocurrency is a security or commodity, which would help inform the regulatory landscape moving forward.

Richard Gorelick presented on the current market structure for the cash and futures markets for cryptocurrencies. He noted that the trading volumes and market caps of the cryptocurrencies tend to skew towards Bitcoin. However, the market continues to diversify as new coins are created. Gorelick further detailed how this is a 24/7 market and how small the increments of coin can be traded, thus creating a highly fluid but thin order book on exchanges. He concluded with a request for a good healthy dialogue between the exchanges in both the financial community and cryptoasset community that will trade and participate in the development of these markets.

Amir Zaidi used his time to discuss an interpretation of the physical delivery exception to retail commodity transaction. He stressed that the proposed interpretation attempts to properly recognize when a purchaser has sufficient possession and control over virtual currency in retail commodity transactions. Zaidi added that this interpretation is a balancing act, to avoid impeding upon market enhancing innovation while ensuring integrity for U.S. retail investors, when the transaction falls within this commission’s jurisdiction. He concluded with adding that the comment period is open until March 20th, should anyone want to comment.

Session Three

The Future of Machine Learning, Artificial Intelligence, and Computing Power

The third session featured a presentation focused on advances in machine learning, artificial intelligence, and computing power and what kind of current and future impact they will have on markets, market participants and regulators. This presentation featured discussion advances in artificial intelligence and its future impact on markets, market participants, and regulators.

Tim Estes, the President and Founder of Digital Reasoning, began his presentation by stating that within a decade there will be no software that does not have an artificial intelligence component, and that improvements in software can be used to monitor markets and detect illicit activity. Estes went on to comment on some of the barriers to the adoption of artificial intelligence technology, including utilization of protected and sensitive customer information and data, along with other economic factors.

Session Four

Developments and Challenges with Automated Trading Technologies

The fourth panel featured practitioners and academics in a discussion of developments, challenges, and risks around automated trading technologies, and potential areas for regulatory consideration.

Larry Tabb began the panel with a presentation that outlined three major types of algorithms: 1) Alpha generating algorithms (which make up about 54% of total equity trading volumes); 2) arbitrage algorithms; and 3) quantitative strategies (about 16% of equity volumes). Tabb next discussed the differences between futures and equities – mainly focusing on the fact that equities have more routing decisions, emphasize speed, and are impacted by liquidity fragmentation.  Tabb also expressed that market regulators should focus on transparency and margins.

Bryan Durkin, discussed the importance of algorithmic trading and proprietary trading in providing market liquidity. Durkin highlighted the benefits of proprietary trading, as demonstrated during the October 15th, 2014 U.S. Treasury market flash rally, where such firms played a pivotal role in contributing to a steady market during stressed times.

Additionally, Durkin pointed out that CME has developed capabilities to manage risk, volatility and market disruption via credit controls, price protection points and stop logic functionality, noting that these protocols apply to all market participants.

Yesha Yadav ended the panel with a discussion on how the standards of legal liability and intent are poorly adapted to the automated trading marketplace. The human understanding of intentional harm is difficult to program in an algorithm that may view an intentionally malicious act as profitable.  Yadav stated that there must be dialogue on how to bring the law up to speed with the pace of technology underpinning trading and securities markets today.

Session Five

Cybersecurity Developments and Best Practices

The final panel of the day covered a discussion regarding emerging trends and best practices in cybersecurity.

Naeem Musa opened by discussing the emerging threat of sophisticated cyberattacks that have come to rely on hacking, malware and social engineering. He noted that financial services organizations are the most targeted victims, resulting in more breaches than any other sector. Musa noted that the CFTC is constantly reviewing and updating their cybersecurity protections to guard against the growing threat of breaches. He added that they are seeking opportunities to utilize artificial intelligence, machine learning, and automation, to strengthen our ability to combat the constant morphs nature of cyber risk. Concluding, Musa noted that, at a minimum all organizations should focus on governance, risk assessment, access rights and controls, data loss prevention, vendor management, training, and incident response.

Phyllis Schneck concluded this final panel with a high-level discussion of technological tools and resiliency. She observed that a limitation of machines is that everything is executing instructions without thinking about what it’s doing next. She stated that someone needs to put logic into what is being executed in order to determine what it means. Schneck stressed that resilience goes beyond compliance – if compliance involves checking boxes, rest assured bad actors are checking those boxes too. She concluded with promoting the use of private-public partnerships in order to improve resiliency for the industry as a whole.

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