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Many of us may feel like this right now coming back to the office or booting up the laptop…
So, we’ll start off with our familiar and cherished Enforcement Roundup, touch on emergency funding for the CFTC’s Whistleblower Program, talk about the CFTC’s advisory on artificial intelligence, get you ready for updates to the FX Global Code, continue our conversation on tokenization, and smooth into an easy update on which form to file for those of you trading cotton. We’ll close it out with some serious derivative related water cooler conversation starters in our “Other Interesting Links” section. Get your index finger ready to scroll. Here we go…you can do this. Happy 2025.
Enforcement Roundup
The CFTC stuck to the classics as it went through December issuing five enforcement actions regarding fraud and misappropriation concerning futures, digital assets, foreign exchange, and commodity pools. At the beginning of the month (December 4), the CFTC also released its FY 2024 Enforcement results, with the main headline being that the CFTC had another record-setting year by imposing more than $17.1 billion in monetary-relief--$12.7 billion of which was awarded in the CFTC’s enforcement action against FTX and Alameda. The CFTC also brought 58 new enforcement actions in FY 2024, including precedent-setting digital asset commodities cases and its first actions addressing fraud in voluntary carbon credit markets, as well as fraudulent/manipulative trading, recordkeeping and reporting violations, misappropriation of confidential information, and trade practices violations. While the CFTC secured record relief in FY 2024, it also filed the least number enforcement actions since FY 2017 when it filed 49 enforcement
actions.
A common question we hear from clients is “what will be the CFTC’s enforcement focus this year?!” That is a very difficult question to predict an answer to, especially with the new administration, and we still don’t know who will be leading the CFTC with CFTC Chair Rostin Benham stepping aisde in January 2025. However, fraud and other violations that involve a clear fact pattern of client or market harm are always the easy answers. In addition, it would not be surprising to see more enforcement actions that include violations of the CFTC’s whistleblower protections, which seem like low hanging fruit akin to the CFTC’s pursuit of recordkeeping violations for offline communications. As a recap, in June 2024, the CFTC brought its first enforcement action
against Trafigura Trading LLC for impeding whistleblower communications with the CFTC in violation of the CFTC’s broad non-disclosure provision (17 C.F.R. 165.19) through confidentiality restrictions included in employment and separation agreements.
For our SEF and DCM readers, we may see an increased focus Core Principle Violations. There were two enforcement actions brought against three registrants based on Core Principle Violations in 2024 – twice as enforcement actions and three times the registrants impacted as in 2023. Is the CFTC testing the waters? We also saw the CFTC remind SEFs and DCMs of the Core Principles through guidance on carbon credits and artificial intelligence in 2024. For our swap dealer readers and other readers, this could have trickle-down effects impacting your engagement with SEFs and DCMs. But, again, the new administration is impossible to predict at this point. We look forward to providing you more insight as the year progresses!
Here is a link to the CFTC’s December enforcement actions.
Tiffany Payne, Yiran Jiang | Email
Government Shutdown Averted and CFTC Whistleblower Program Extended
The CFTC’s whistleblower program received an extension in the December 20 bill meant to also fund the government through March that has since been passed by Congress and signed in to law. The CFTC’s whistleblower program (including the staff that supports it) was originally financed entirely by sanctions collected by the whistleblower program.
In 2021, Congress passed an emergency piece of legislation funding the whistleblower program with tax dollars instead of funding solely from sanctions collected by the whistleblower program. That 2021 emergency piece of legislation was set to expire on 1/1/2025 and the permanent funding solution for the whistleblower program is still pending in Congress – even though it has largely bipartisan support.
Barrett Morris | Email
CFTC Advisory On The Use of Artificial Intelligence
Artificial Intelligence (“AI”) is everywhere you look right now. AI is a lot of things, but for most of the market it is simultaneously a buzzword for innovation and efficiency, and a bogeyman for fraud and privacy concerns. As such, AI is a technology that banking and markets regulators, like the Commodity Futures Trading Commission (“CFTC”) are watching closely. On December 5, 2024, the CFTC issued a staff advisory (the “Advisory”) regarding the use of AI in CFTC-regulated markets.
Foremost, the Advisory reminds registrants that despite the technological innovation and expected efficiencies that AI brings, registrants remain responsible for compliance with all applicable requirements under the Commodity Exchange Act (“CEA”) and CFTC regulations. As such, the CFTC expects registrants that implement AI, either directly or through third parties, to assess the risks of using AI, make updates to policies, procedures, controls, and systems and ensure that the implementation of AI has been reviewed for compliance with the CEA and CFTC regulations. CFTC registrants should also be prepared to discuss AI as CFTC Staff may incorporate AI as a topic of discussion in their routine oversight activities such as examinations.
The Advisory also discusses interesting use cases for AI among registrants such as: (i) order processing, (ii) detection of abusive trading practices, (iii) settlement, (iv) calculation or collection of initial margin and variation margin, (v) chatbots, (vi) recordkeeping, and (vii) disclosures. The Advisory discusses these use cases under different types of registrants, but generally, the CFTC’s discussion of these use cases should be considered by all registrants. The use cases closely follow those that Commissioner Johnson shared in her remarks at the April 2024 FIA L&C. While the Advisory is helpful to appreciate some of the different applications of AI by registrants, the bottom line is that despite the different potential uses of AI, registrants remain accountable for compliance with the same long-standing regulatory requirements. As such, registrants adopting AI should carefully consider all applicable CEA and CFTC regulations as they work to implement AI. Certain registrants (e.g., DCOs, DCMs, SEFs, and SDRs) should also be cognizant of their obligation to provide advance notice of all “material planned changes to automated systems that may impact the reliability, security, or adequate scalable capacity of such systems.”
Both Chairman Behnam and Commissioner Johnson released statements concurrently with the issuance of the Advisory. Chairman Behnam’s statement champions his accomplishments to bring AI into the consciousness of the CFTC and notes the CFTC’s own use of AI to “upskill staff and leverage data to optimize the agency’s limited resources to better monitor risk, surveil for market integrity, examine for compliance, and enforce to deter unlawful trading behavior in our markets.” Commissioner Johnson’s statement repeats her call for the creation of an interagency AI Fraud Task Force to root out and hold accountable bad actors that use AI as part of their fraudulent schemes – which she notes are increasing in sophistication.
The Advisory follows the CFTC’s January 2024 Request for Comment on the Use of Artificial Intelligence and Commissioner Johnson’s related statement that raised the possibility of rulemakings regarding the integration of AI in CFTC-regulated markets. While vague, the Advisory also notes that CFTC Staff will “continue to evaluate the need for future regulation, guidance, or other Commission or Staff action.” As of the date of this article, it is unclear who will be the next Chair of the CFTC or the makeup of the Commissioners, so it is hard to predict the CFTC’s view on AI moving forward or what policies may follow. One thing is for certain though, the use of AI will continue to increase among CFTC registrants and market participants causing new and novel considerations about compliance with the CEA and CFTC regulations. Moreover, other governmental authorities, such as the Department of Justice,
also continue to emphasize the need for companies to address emerging risks associated with the use of AI and other technologies. It is therefore critical for CFTC registrants to consider AI governance, risk assessment, system safeguards, and regulatory compliance when adopting new AI or other technology tools, whether internally developed or offered by third-parties.
Barrett Morris, Nader Raja | Email
Updated FX Global Code Expected in January
We talked in November about the Global Exchange Committee’s (GFXC) request for feedback on proposed amendments to the FX Global Code, which centered on elements of FX settlement risk and netting under Principles 35, 50, and 51.
The update will be timely and is on the mind of regulators as evidenced by Philippe Lintern’s (the Bank of England’s head of foreign exchange) early December remarks warning trading venues and market participants who have not adhered to the FX Global Code that they will have “hard questions” to answer for not adhering to the FX Global Code. Much of Lintern’s remarks (wrapped in Shakespeare’s Henry V) focused on FX settlement risk and what Lintern alleges is a failure of the mitigation of FX settlement with the development of the FX market. Lintern gives a subtle reference to SVB’s failure noting “the failure of a mid-sized US bank which did not use PvP brought this risk into sharp relief.”
BIS estimated that in April 2022 almost a third of deliverable turnover FX ($2.2 trillion or about 31% of deliverable turnover FX) was at risk. Lintern cites a figure that the percentage of unmitigated FX bilateral settlement is now at 10 to 15%...while a huge improvement in merely two years, still a substantial risk. FX settlement risk is usually considered a sell-side issue, but Lintern asks all market participants to adopt the best risk mitigation possible. Lintern also encourages all market participants to revisit and review FX settlement practices.
The updated version of the FX Global Code is expected to be released in early January 2025 and accompanied by a paper outlining the comments and responses received by the GFXC’s request for feedback.
Barrett Morris | Email
Tokens, Settlement, Continued
If I had used the actual title of the research paper here (“Regulated Settlement Network Proof of Concept”) you probably would not have read this update. While this topic may not sound exciting to the everyday reader, I can assure you that the tokenization of everything is a wildly exciting advancement for swaps, derivatives and banking generally. This is a topic we reported on previously when we covered the CFTC’s guidance on distributed ledger technology and one I expect we will be revisiting.
Several US banks and other regulated financial entities worked with SIFMA to test how “tokenized multi-asset and cross-network settlements may be achieved through the use of shared ledger technology and an interoperability solution.” The regulated settlement network (“RSN”) provided a common settlement structure for tokenized securities, tokenized central bank deposits, and tokenized commercial bank deposits. The test allowed for 24/7 settlement and each bank was able to connect its partition with third party networks. At its core, the RSN is distributed ledger technology that can be used to register and transfer ownership of tokenized securities, tokenized central bank deposits and tokenized commercial (or wholesale) bank deposits.
The RSN’s legal analysis states that “as conceived, the tokenized central bank deposits and tokenized commercial bank deposits that would be available for transfer through the RSN should not be considered securities or be subject to the regulatory jurisdiction” of the CFTC. The legal analysis supporting the test of the RSN comes to the same conclusion for tokenized securities and ultimately that the tokenization of these assets should not be considered separate legal instruments themselves – instead this is a secure and quick way to record and transfer ownership of the tokenized asset.
Barrett Morris | Email
CFTC Advisory 24-18
The CFTC issued an advisory in mid-December that starting on January 15, 2025 all merchants and dealers of cotton or controlling positions for future delivery in cotton subject to CFTC Regulation 17 CFR 19.00(a) must submit a Form 304 through the CFTC’s online filings portal. Prior to January 15, 2025, the Form 304 can be submitted via email. This advisory ends the relief market participants previously relied on under No-Action Position No. 13-14.
Barrett Morris | Email
Other Interesting Links:
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