Greg Kilminster
Head of Product - Content
CFTC rule proposal could see ban on range of outcome-based events
The Commodity Futures Trading Commission (CFTC) has issued a proposed amendment to CFTC regulation 40.11 to specify further the definitions of event contracts that Are defined in section 5c(c)(5)(C) of the Commodity Exchange Act (CEA). This section of the CEA cites gaming, war, terrorism, assassination, and any activity that is unlawful under any Federal or State law as ones which are contrary to public interest and hence may not be listed or made available for clearing or trading on or through a registered entity.
The proposed change however elaborates on the definition of ’gaming’ and provides a number of examples (“staking or risking something of value on the outcome of a political contest, an awards contest, or a game in which one or more athletes compete, or an occurrence or non-occurrence in connection with such a contest or game”) which would not be liable for listed trading.
The proposal has seen two commissioners, Caroline Pham and Summer Mersinger, express their disagreement with the proposed rule.
In her statement, Mersinger expresses concern that the proposed rule will “prohibit entire categories of potential exchange-traded event contracts whose terms and conditions the Commission has never even seen.” She also raises concerns about the proposed broader definition of ‘gaming’ which is extended to include “any other occurrence or non-occurrence in connection with” a game. As she points out, this would effectively affect “event contracts involving the attendance at a baseball or football game, or whether a particular nation will be selected to host a soccer World Cup” adding “it is difficult to fathom why an event contract involving whether Taylor Swift will attend a Kansas City Chiefs football game should constitute ‘gaming’.” Noting the proposal sweeps all ‘contents’ into the definition of ‘gaming’, Mersinger points out that any event contracts on election results or awards would also be prohibited.
Meanwhile, in her statement Pham notes her belief that “the Commission fundamentally misunderstands the law in [event contracts related to gaming]” and encroaches into State regulation of gaming that may lead to event contracts being forced underground into illegal and unregulated offshore markets. She also expresses her concern that the proposal:
- Contains “an alarming new delegation of authority to let staff—rather than the CFTC—decide when event contracts fall within a prohibited category”.
- Does not mention any of the comment letters the CFTC received on the definition of gaming, as well as regulation 40.11 and event contracts more broadly.
- “Gets hung up on the fact that ‘it is not tasked with the protection of election integrity or enforcement of campaign finance laws’ in justifying prohibiting event contracts based on political contests.”
The consultation period for comments on the proposed rule change closes on 9 July 2024.
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SEC Commissioner Mark Uyeda speech on the role of economists in regulating financial markets
In a speech at the Securities and Exchange Commission’s (SEC) 11th Annual Conference on Financial Market Regulation, SEC commissioner Mark Uyeda applied a philosophical approach to describing the SEC’s regulation of financial markets.
Uyeda began by noting that an economically classical perfect competitive market, whilst useful for analytical and predictive purposes, will, if not policed quickly result in “sub-optimal outcomes” such as fraud, and driving all honest issuers out of the market. Hence the need for regulation and he noted that the initial set of federal securities laws passed 90 years ago have held up well. By relying on market mechanisms and disclosure, those laws have contributed significantly to the success of US financial markets.
Uyeda also noted the 1996 National Securities Markets Improvements Act, which requires the SEC’s rulemaking to consider “in addition to the protection of investors, whether the action will promote efficiency, competition, and capital formation.” Noting the need to consider potential trade-offs from this obligation, he introduced the notion of the SEC adopting a scientific approach to regulating the markets.
To explain this further, Uyeda firstly took the audience through a brief history of the philosophy of science and the methodical insights established during that evolution and then applied those insights to financial markets. In short, this section of his speech noted that understanding and navigating the complexities of financial markets presents formidable challenges, primarily due to their dynamic and rapidly evolving nature. The intricate interplay of technological advancements, regulatory changes, demographic shifts, and infrastructural developments continually reshapes the landscape, making it difficult to establish a consistent theoretical framework over time. Traditional modeling approaches face limitations in capturing the fluidity of these markets, as what may have been considered reliable in the past can quickly become outdated in the face of ongoing developments. This dynamic environment necessitates continuous economic analysis and regulatory scrutiny to assess the impact of changes accurately, particularly within regulatory bodies like the SEC, which must make timely policy decisions amid a constantly shifting landscape.
Furthermore, financial markets are characterised by asymmetries of information, complex feedback loops, and evolving principal-agent conflicts, further complicating regulatory efforts. The advent of information technology has brought about rapid changes in business models and market dynamics, challenging regulators to adapt while promoting innovation and mitigating risks.
Despite these challenges, effective regulatory frameworks must strive to maintain a balance between promoting competition and safeguarding market stability, recognising the fragility of maintaining a competitive ecosystem amidst technological disruption.
In summary, navigating the analytical challenges inherent in financial markets requires a nuanced understanding of their dynamic nature and a proactive approach to regulation that anticipates and responds to ongoing developments in the industry.
The role of SEC economists
Noting the above, Uyeda added his support to the role of economists in helping the SEC formulate policy. As well as acting as gatekeepers to help ensure regulation is consistent with its statutory requirement and promoting efficiency, competition, and capital formation, Uyeda added that economists employed by the SEC should also contribute as follows:
- Economists should be analysing the impacts of incentive structures, and estimating the consequences, including unintended consequences and should be using their analytic and evidence-based skills in tracing and measuring the impact of shifting conflicts of interest that can potentially undermine the markets’ ability to facilitate capital formation and harm investors.
- Economists should bring to bear insights and hypotheses that may be different than those from lawyers and accountants.
- Economists not only need to do quality cost-benefit analysis prior to the adoption of a rule, but they need to regularly conduct ex post cost-benefit analysis as well.
- Economists need to interact regularly with other interested economists through internal and external research efforts. These interactions cannot be limited solely to economists in academia, but also in industry and in government.
SEC’s regulatory approach
In the light of the discussion, Uyeda finally turned to how the SEC should approach regulation, pointing out the constant state of flux of the markets necessitates a “regulatory framework that facilitates a competitive and decentralised knowledge process that constitutes the markets themselves”. He added that the SEC should focus on dealing with key market externalities and should refrain both from meddling with the decentralised pricing system of the markets and from addressing theoretical concerns with respect to aspects of the markets that are generally working well. Uyeda concluded by stating that economic analysis is essential at every stage of rulemaking, from identifying market issues to evaluating rule effectiveness post-implementation. It guides decision-making, ensures regulatory efficiency, and promotes effective oversight in the financial sector.
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CFTC’s first action against unregistered futures commission merchant
The Commodity Futures Trading Commission (CFTC) has fined Falcon Labs, Ltd $589,504 for failing to register with the CFTC as a futures commission merchant (FCM). This is the first time the CFTC has successfully brought an action against an unregistered FCM that inappropriately facilitated access to digital asset exchanges.
Between October 2021 and March 2023, Falcon Labs engaged in soliciting and accepting orders for digital asset derivatives from US-based customers, acting as an intermediary for trading on various digital asset exchanges. To facilitate customer access, Falcon Labs established main accounts in its name and then created associated sub-accounts, typically without requiring or providing customer-identifying information for the sub-account holders. During this period, Falcon Labs amassed approximately $1,179,008 in net fees from customers involved in digital asset derivative transactions. Following a complaint filed by the CFTC against other entities involved in similar practices, Falcon Labs voluntarily enhanced its customer identification controls.
As well as the fine, the action requires Falcon Labs to pay $1,179,008 in disgorgement.
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SEC and FinCEN propose customer identification program requirements for RIAs and ERAs
The US Securities and Exchange Commission (SEC) and the US Department of the Treasury’s Financial Crimes Enforcement Network (FinCEN) have jointly proposed a new rule that would require SEC-registered investment advisers (RIAs) and exempt reporting advisers (ERAs) to establish, document, and maintain written customer identification programs (CIPs).
Some context
Investment advisers are not currently subjected to comprehensive anti-money laundering (AML) and countering the financing of terrorism (CFT) requirements like regulated institutions under the Bank Secrecy Act (BSA). Some advisers voluntarily implement AML/CFT programs, while others have not yet implemented any comprehensive measures.
On 13 February 2024, FinCEN proposed a new rule that would expand the definition of “financial institution” under the BSA to include RIAs and ERAs. FinCEN has requested feedback on various aspects of the proposed rule by 15 April 2024.
This proposed rulemaking complements this FinCEN proposal.
Key takeaways
The proposal would require RIAs and ERAs to implement a CIP that includes procedures for:
- Verifying the identity of each customer to the extent reasonable and practicable.
- Maintaining records of the information used to verify a customer’s identity, including name, address, and other identifying information.
This proposed rule is generally consistent with existing rules requiring other financial institutions, such as brokers or dealers in securities, open-end investment companies (such as mutual funds), credit unions, banks, and other financial institutions, to adopt and implement CIPs.
Next steps
The deadline for feedback is 60 days after publication in the Federal Register.
Click here to read the full RegInsight on CUBE’s RegPlatform
EBA issues CP on draft RTS on equivalent mechanism for unfinished property under the standardised approach of credit risk
The European Banking Authority (EBA) has issued a consultation paper (CP) on the draft regulatory technical standards (RTS) on the equivalent mechanism for unfinished property under the Capital Requirements Regulation (CRR3). These technical standards specify the conditions that a legal mechanism should meet in order to recognise a property under construction in the own fund requirements calculation under the standardised approach of credit risk.
Key takeaways
The draft RTS clarifies that an equivalent legal mechanism requires three conditions to be met:
- An entity should be required to or have committed in a legally binding manner to ensuring that the property under construction will be finished within a reasonable timeframe.
- This entity should have the legal powers and ability to do so.
- A counter guarantee is provided by a central government or assimilated entities.
The CP also presents an alternative approach, with a more comprehensive understanding of the equivalence legal mechanism and aimed to capture completion guarantees already in place in some EU jurisdictions.
Next steps
The deadline for feedback is 7 June 2024.
Click here to read the full RegInsight on CUBE’s RegPlatform
ASX issues consultation on changes to operating rules and procedures
The Australian Securities Exchange (ASX) has released a consultation paper outlining proposed amendments to the ASX 24 Operating Rules and Procedures (ASX24OR) and ASX Clear (Futures) Operating Rules and Procedures (ASXCFOR).
The purpose of this consultation is to obtain feedback on proposed amendments to ASX24OR and ASXCFOR that relate to:
- The reporting of Open Positions in ASX 24 Derivatives Market Contracts (and related changes).
- The five year review and refresh of the ASX Clear (Futures) Operating Rules and Procedures.
Next steps
The deadline for feedback is 12 July 2024.
Click here to read the full RegInsight on CUBE’s RegPlatform
IMF issues results of Japan financial sector assessment program
The International Monetary Fund (IMF) has released the results of the Financial Sector Assessment Program (FSAP) for Japan.
Some context
The FSAP is a mandatory exercise conducted by the IMF as part of Article IV surveillance to evaluate the stability of the financial system in member countries. This assessment helps identify major sources of systemic risk and proposes policies to improve resilience against shocks and contagion. In Japan, this exercise is conducted every five years, with the most recent one taking place in 2017.
Key takeaways
According to the concluding statement, the systemic risk analysis conducted as part of the FSAP suggests that the financial system is broadly resilient to a range of adverse macro-financial shocks, but some areas merit attention and close monitoring. Risks from climate change and growing digitalisation, including cyber risks, also need to be carefully monitored. Financial sector policies have been strengthened in recent years, but further steps are warranted to maintain financial stability in an evolving risk environment.
The FSAP's findings are summarised in technical notes, based on the information available at the time of completion, which was 16 April 2024. The technical notes cover:
- Regulation and supervision of investment funds
- Systemic risk analysis and stress testing
- Cyber resilience and financial stability
- Financial supervision and regulation of climate-related issues
- Banking supervision and regulation selected issues
- Financial system stability
- Financial safety net and crisis readiness
- Detailed assessment of observance on insurance core principles
- Regulation and supervision of Fintech
Click here to read the full RegInsight on CUBE’s RegPlatform