JONES DAY TALKS®: We Got This: CFTC Chair Pursues Authority Over Digital Assets
As discussions and debates unfold over digital currency regulations, Commodity Future Trading Commission chairman Rostin Benham told a U.S. Senate committee that "speculative fervor" surrounding cryptocurrencies has potentially left investors in need of protections, and made the case for his commission to be charged with overseeing activities in this burgeoning market.
Jones Day's Josh Sterling and David Aron discuss the gradual move toward federal oversight of cryptocurrencies, the questions clients ask, and what crypto market participants need to know now.
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A full transcript follows.
Dave Dalton:
There appears to be no end in sight for the surge of interest in activities surrounding cryptocurrencies. The opportunities are intriguing, but as often happens the regulators are trying to catch up to the technology and innovation. During a recent U.S. Senate Agriculture Committee hearing, the chair of the CFTC or Commodity Futures Trading Commission made the case that his commission should have jurisdiction over crypto. Jones Day's Josh Sterling and Dave Aron are here to weigh in. Stay here, I'm Dave Dalton, you're listening to JONES DAY TALKS®.
Dave Aron recently joined Jones Day as a council in its smash markets practice based in the Washington D.C. office. He most recently served at special council and the division of data at the U.S. Commodity Futures Trading Commission or CFTC, where he played key role in writing a number of Dodd–Frank Act implementing regulations. He also served as liaison and provided significant assistance to the CFTCs division of enforcement and multiple swap rules related investigations. You'll hear more about Dave's background and experience in a moment.
And Jones Day's Josh Sterling has more than 20 years experience in the derivatives and security markets, both as lead council to major companies and as a senior federal financial regulator. Josh represents clients that are active in the derivatives markets with matters before the U.S. Commodity Futures Trading Commission, the U.S. Securities and Exchange Commission, and various self-regulatory organizations including, the National Futures Association and the Chicago Mercantile Exchange. Prior to joining Jones Day, Josh was Director of the CFTCs Market Participants Division, which regulates 3,300 banks intermediaries and asset managers registered with the agency to trade derivatives in the U.S. market. Josh, Dave, thanks for being here today.
Josh Sterling:
Thank you.
David Aron:
Thanks, Dave.
Dave Dalton:
Dave, let's go to you first. First of all welcome to Jones Day. You're relatively new to the firm, tell us a little bit about your background and some of your experiences prior to coming here.
David Aron:
Sure. Well, I'm super excited to be here and working with Josh. I am a derivative lawyer from way back, started at MetLife in house out of law school, did a wide range of investment work there. And I moved to Citibank where I supported primarily the equity derivatives trading desk, but also some of the credit derivatives guys and little backup with the interest rates, FX and commodities. And then I moved to the CFTC the first time for a couple of years, I worked directly for the division director and back then the current operating divisions were all wrapped up into one. So it was a pretty great gig. And then I was recruited from our former chief council, Susan Irvin to go work with her at Dechert. My first law firm stop, we did mostly CPO and CTA work and also some OTC derivatives for representing funds, fund complexes, registered, and also hedge funds.
Then I was recruited to McDermot where I did a lot of gas and power, physical energy trading and some other commodity work and CFTC regulatory. And then I went to Schulte up in New York where I did credit derivatives, CDS and CDOs and helped cause the financial crisis, unfortunately. And when that blew up, I was at the UN for a couple years, and then I got to undo some of my evil by going back to the CFTC and helping write the Dodd–Frank rules. Fantastic. And I was there for too long and I missed my chance to come join Jones Day many years back, but thank God I'm here now and I'm having a great time.
Interesting background. What do you expect to be your client focus? What sort of matters we'd be working on here at the firm?
David Aron:
Well, anything Josh wants, but a lot of trading platform registration with the CFTC, there's a couple of different categories with DCMs and SETHs and some renewable energy derivatives, Dixon Chins got some interesting work there. The actional derivatives work down the road, I believe some security based swap regulatory work with Peter Petraro, and crypto, we've already had some interesting crypto questions and that's the broad range that about right now.
Dave Dalton:
Well, you certainly arrived here at an interesting time and I thank you again for joining our program today. So let's jump into our topic. Josh Sterling, let's get going here. During a February U.S. Senate Committee hearing, CFTC Chairman, Rostin Behnam said that speculative fervor surrounding cryptocurrencies has potentially left investors in need of protection. What sort of problems is the chairman worried about, or perhaps maybe anticipating?
Josh Sterling:
Thanks for that, David. Again, it's always great to be here and I've got to say that we missed the part in David Aron's resume where he said he caused the financial crisis and will not turn him into the relevant authorities. I think the statutes run on that.
Dave Dalton:
He's broken major story here at Josh Day.
Josh Sterling:
That's right. Coming here first. So on the hearing, yeah, I thought it was an especially a powerful and helpful hearing for the public debate on regular of digital assets. The Chairman, Ros Behnam was quite right to focus on customer protection concerns. Those are core of the mission of any markets regulator like the CFTC. Some of the concerns he has break down along the following lines. First of all, there's a concern about people not understanding the products in the markets that have been approved and in the markets that the CFTC regulates. So whether it's trading futures on Bitcoin or investing in a fund that trades futures on Bitcoin or any other cryptocurrency, there can be an investor concern around that investor protection customer concern.
The other issue is if you're buying and selling the tokens themselves, which I think is way more prevalent than say futures trading on tokens. If you're buying and selling those, there are opportunities for people to be taken advantage of, CFPC as well as the SCC and frankly criminal authorities. Case announced just a couple weeks ago where they uncovered a four and a half billion dollar crypto heist. And there's real opportunities out there for theft or to put your money into a system under false pretenses and someone absconds with the money. So I think he's worried about that as well.
And a particular concern there too. I can't recall whether he mentioned it, but certainly the other current remaining commissioner staff, has said, "We need to police these markets for the tokens themselves." But remember that we the CFTC regulate the derivatives markets. So futures on crypto, futures on anything, we regulate this markets. We do not regulate and require registration of markets where the crypto itself trades and we don't want investors, customers who buy and sell tokens to think the CFTC is walking that beat, like it does say Chicago Mercantile Exchange or Futures Exchange.
Josh Sterling:
There are concerns on a lot of levels out there. They want to do their job, they want police for misconduct and have the tools to do that in the cash or spot market for tokens themselves. But they don't want to create the impression that there's this comprehensive federal scheme out there to regulate that because there's not. Here's a bit of a D.C., a jurisdictional battle going on over which regulator or regulators might get a piece of that market to regulate.
Dave Dalton:
Sure. Josh, when we talk about these things, we always come back to consumer protections and that's what commissions and agencies are there to do. Crypto is so new, not to you guys maybe, but to people like me, to typical investor, consumer, the guy out there, this is still new is much of the problem just because people don't know enough about it yet, they get excited they hear about this stuff. There aren't inherent defects, if that's the right word in these products. There's malfeasance going on. It's just that maybe people don't understand what they might be getting into or doing sometimes, is that where the protection comes in?
Josh Sterling:
There are unfortunately some notable cases where people have lost their money digitally, which just taken, taken and by malefactors. So that's certainly a concern, but there is this abiding customer protection concern. We're living now with 80 plus years, 90 plus years of regulation and the securities laws, lies laws are about that old too. That does have very much a customer protection focus and that those laws came of age and are still relevant today, of course, where you have a market, which is a place where people go or log in now. They're mostly electronic of course, to trade and it's centralized. You have intermediaries, you trade through, say a broker, an investment advisor, your opposite of dealer. You go on an exchange and your trade is cleared, and each of those point there's regulation and where the money is kept say, it's in a bank, there's regulation there too and it can be federal state or both.
Well, you get into crypto land and everything's on a blockchain. These are essentially smart contracts and sells zeros and ones. It is quintessentially dis-intermediated, that's one of the distinguishing characteristics of it for good or ill.
Dave Dalton:
Right.
Josh Sterling:
And so who does what, and how do you get them? Now, in the criminal case and the civil enforcement case so forth, because these blockchains are all public, matter of public record, all the transactions you can and run it down, FBI's gotten pretty good at that, for example. But along the way, it's not as if you can call up as easily, say a broker as you can in securities land when you have a concern about insider trading or someone manipulating a market or something, and that's the concern too. How do you police it, because it's very much decentralized?
Dave Dalton:
Sure. I guess that's inherent to the process. Let's go back to David Aron for a second. Dave, the way the law is currently written, the CFTC regulate derivatives like futures and swaps, but not cash or spot markets. What would have to happen to give the CFTC this authority to regulate the cash and spot markets?
David Aron:
They do have authority to pursue fraud and manipulation, even in the cash/spot markets right now in crypto and other commodities in the past. So they've got some experience with that, but Congress would have to change the Commodity Exchange Act to grant them that day to day authority to require trading platforms of spot crypto, to register an X category, maybe in an existing one or a new one. It's been a long road already with Congress trying to pass a number of bills. A number of bills have introduced over the last several years to do that or to get the SCC authority or to get join authority. But historically, CFTC and SCC haven't always played nice together and there's turf battles. They do try, it's not malicious in any way, but it's very difficult. Just to know where the line is to agree with another agency on it and then they don't even have, it's just based on today's authority.
Dave Dalton:
Well, in fact, that segues nicely into the next point because Josh, we've talked on previous podcasts about regulatory and enforcement powers given to the SCC, the Justice Department and even state regulators and authorities. Why might the CFTC potentially be the right choice to provide oversight for the cryptocurrency matters?
Josh Sterling:
Dave Aron makes a great point, and it's a great question, Dave. So there has been a discussion out there about whether the CFTC would be the right regulator for the cash markets and digital assets, and that was the thrust of the hearing last week. Some of the arguments in favor of the CFTC being given this jurisdiction perhaps on an exclusive basis would be that the regulator is very much focused on having clear principles around which its regulations are formed. And what that allows it to do is to sort of pursue new areas along the lines of those specific principles that they have being a principles based regulator. And I think that's very helpful when you get into an area with evolving in new technologies. Some of these technologies will be used by existing financial services firms, some of the technologies ultimately might replace some of those firms and I'm not here to make a prediction, but I can see both being possible.
And if that's true, working with a regulator that's focused on principles can be quite helpful. That would be one of the arguments that there's a degree of flexibility. And I don't mean this in an inappropriate way. There is a culture of learning at the CFTC and the willingness to understand new products. This is not capitulating to whatever business wants, far from it I can assure you and I'm sure Dave can as well, but rather than try and work and find a solution. And I guess the final thing I would say is that where there isn't a solution, if the answer is no, it will be cleared and it will be understood and people might not like it, but ultimately they can live with it. The final reason is that when the CFTC is policing the markets for misconduct, it will laser focus on true misconduct where there is a disruption to pricing, meaning a manipulation of the market or a deliberate disruption in the market where there's fictitious trading or uneconomic trading.
It'll focus like a laser on that and it'll bring a pile of bricks down on someone. When you have violations or issues under more technical rules, rules that are intended to keep everything moving in the right direction, you need to have timely reporting, you need to have appropriate capital levels, all those sorts of things. There are penalties for non-compliance and non-compliance is real if you've violated or allegedly violated federal law. But the penalties are not meant to shut down businesses, the penalties are not meant to send any more message than this conduct was wrong and everybody needs to know about it and contrast some other regulators. When the CFTC goes to bring a case and assess penalties, there is a definite effort to tie the scope of those penalties and remedial measures to what actually went wrong and how bad it was. And I'm not sure that's always true with every other regulator today.
Dave Dalton:
Yeah. We've heard those stories, and just rewind for a second, I liked what you said about this being an institution that keeps the ball between the forties. Because we recorded another podcast recently with one of your partners and he was talking about, there are whims, political whims sometimes depending on how the commission or how the committee or whatever is at stacked, that can affect enforcement and policy going forward. So I like what you said about the CFTC as a regular guy out there, an investor or consumer, that's a great way to see this and stuff we like to hear more of.
Let's go back to Dave for a second. Talking about this regulations and so forth and whether or not we keep it in the forties and who does it, it does seem like players in the crypto space are getting used to the idea or even warming to the idea that at least some federal oversight might be necessary. Now Dave, is this something that could happen quickly, be it with a CFTC or some other commissioner agency based on your experience?
David Aron:
In our dreams maybe. Josh and I have talked about this. Josh has heard that it might take another few years to get everything together, because to date it's been Congress looking to the regulators and passing some bills or not passing, introducing some bills, but unfortunately they haven't passed. With all kinds of creative approaches, a new regulator SCC and CFTC work together, just the CFTC, just the SCC. And then the regulators are asking Congress that the market regulators, the CFTC, and SCC have been asking Congress for clear authority in certain areas. Ros Behnam just suggested that the CFTC would comfortable taking on the spot market authority but with a bigger budget, of course, because it's a much bigger ask.
So I don't think it's going to happen anytime soon. The regulators could put out some more guidance, but they can't give themselves more authority or sometimes they try and then they lose in court and somebody pushes them on that. I don't know what exactly it's going to take because they've been a number of hearings, including recently where Congress tries to educate itself or make some points in public about what they care about and we haven't really gotten enough momentum. We just have to wait and see, I guess, or lobby.
Dave Dalton:
I remember that the Wall Street Journal ran an article the day after this Senate Ag Committee hearing, CFTC is going to be a hundred million that they like to help with regulatory and enforcement work. And I know that's not a lot of money by Washington standards, but does that figure sound right to you Dave, based on your experience? I know it takes a lot to do this right, a hundred million bucks though, right?
David Aron:
It doesn't even sound like that much when you think about it, because I think the budget is like, it'd be nice if I had it, but for the agency they have about 400 million something budget approximately anyway. So to take on this huge space with a trillion or three trillion, whatever the interest is, it doesn't seem unreasonable, depends what your view is of big government or not. But if they're going to take on a whole huge new market like this, then they definitely will need new people and people with different experience coming in from industry and that costs more. So it doesn't seem out of the-
Dave Dalton:
Dave, thanks for that. Because again, you lead me very well into the next question because Josh, I'm thinking if this does happen, if the CFTC has grant this sort of authority, this would be a significant extension of that authority. Because the sheer size, the crypto market, and also to the fact that CFTC is primarily regulated only derivatives, is this a fair assessment or am I making inferences I shouldn't be making here?
Josh Sterling:
I do think it would be a significant expansion of the authority, which is an odd position to be in to say that, because if you look at the definition of a commodity, Commodity Exchange Act, it starts out saying pretty much anything in the world except two things, onions and motion picture box office receipts. And so literally anything is a commodity provided that there is or in the future will be a derivative on it. I'm extemporizing here. So that's very broad, but then you get into what actually does the statue regulate. And these are widely regarded derivatives as the largest financial markets in the world. But to get to the underlying thing and regulated substantively rather than just policing for fraud or requiring the collection of information would be significant.
It's significant in the following sense. One of the things I always like to do is tell new lawyers that derivatives contracts are worthless and they say, "What are you talking about? You just told me it's a 30 trillion notional market for swaps." And I say, "Well, they're basically a thought or a guess about what a price is and it could expire and it could be worthless." So there's no intrinsic value to it. It's not an asset that appreciates or depreciates, it's not a store of value. It's not a unit of account, it's not a method of exchange, and crypto can be all of those things. It's a smart contract, it's totally composable. You can make it do very many different things financially that you want. And that's not a derivative, it's a thing that has real value.
And so you'd have to create a market or a scheme to regulate markets and intermediaries that exist today, by the way around things that have intrinsic value. There's the size issue and the budgetary issues which Dave hit on, but there's also just this conceptual issue of, you go from regulating basically price markets, what is the futures market saying about the price of cotton is to regulating a market which is, this is a Bitcoin or an Ether or Cardano, whatever it might be, what is that worth? Well, it's worth something and now we have to place a market like that. So I think even conceptually it's a bigger lift beyond the size of the actual market itself.
Dave Dalton:
Good enough. Dave, Josh, this has been great. Let's wrap up with this lastly. Go to Josh first then to Dave, let's finish with this. What's the main takeaway from the Senate Ag Committee hearing of a few weeks back and Commissioner Behnam's remarks? What does the audience need to know?
Josh Sterling:
Sure. The hearing was excellent and I think that it is showing that the Senate Agriculture Committee, which oversees the CFTC. The CFTC itself feel that they have a valuable and constructive role, maybe even a primary role in regulating the digital assets, marketplace, and ecosystem. That's an important message to get out there. I spend a lot of talk from other regulators about how they're best equipped to do it, perhaps because their chairman have taught a course on this in a college or something like that. But I see here the deliberate, thoughtful and really well grounded approach to getting legislation and getting regulation to follow it, being really focused on getting it right rather than being first. That's a great credit to the committee as well as to Ros Behnam and the leadership and the whole team there at the CFTC. So CFTC and the Ag Committee are in the debate and have a very strong hand.
Dave Dalton:
Dave Aron, finish this up. What would you add to what Josh said?
David Aron:
It's fascinating that the CFTC is in play to be the primary regulator of a cash market. That's big news and there seems to be somewhat wide support in the industry for that, not surprising given the different approaches, the CFTC and SCC traditionally taken. And SCCs really at its core as a retail protection agency and CFTCs sometimes focus more on promoting innovation. So it's not surprising. It'll be interesting to see the SCC's oversight committee. I'm not sure they want to just see the Ag Committee have oversight over such a huge market without the SCC having input and thus they would become less important. So probably a lot of lobbying is and needs to happen behind the scenes and education and just also persuasion and to convince the relevant legislators why the CFTC is the best regulator for this job.
Dave Dalton:
All right. Great summation, great conversation. We will leave it right there. We had a fascinating time with all this. I'm sure we'll talk to you both again. But Josh, Dave, thanks so much for being here today and we'll talk again soon.
Josh Sterling:
Thank you very much.
Dave Dalton:
Thank you. You can find complete biographies and contact information for Dave Aron and Josh Sterling at jonesday.com. While you're there, visit our insights page for more podcasts, videos, publications, blogs, newsletters, and other valuable information. Subscribe to JONES DAY TALKS® Apple podcast or wherever else podcast can be found. Jones Day Talk is produced by Tom Kondilas. I'm Dave Dalton, as always we thank you for listening. We'll talk to you next time.
Speaker 4:
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