Virtual currency presents risks to futures commission merchants (FCMs) when deposited by futures customers or cleared swaps customers to margin futures, options on futures, or cleared swap transactions, according to an Advisory issued on October 21, 2020, by the Director of the CFTC’s Division of Swap Dealer and Intermediary Oversight (DSIO). The CFTC staff Advisory is intended to provide guidance to FCMs on developing risk management programs for holding virtual currency as futures customer funds. A firm that decides to accept virtual currency needs to adopt policies and procedures that go beyond typical segregation funds and which, among other things, limit which types of virtual currency it can accept, how to value the virtual currency for margin purposes, and how to protect the currency against hacks and loss of keys.
The Advisory reports DSIO’s determination that receiving virtual currency from a customer and holding that currency as segregated funds creates additional risks for the other customers in the same origin. This is because custodians of virtual currencies are “typically not subject to a system of comprehensive federal or state regulation and oversight.” Examples of such risks include: the owner or custodian’s failure to effectively safeguard virtual assets or digital keys or loss of digital keys; misappropriation of those keys, hacking of systems designed to hold virtual currencies; and the limited commercial insurance to cover virtual currency losses.
To address these risks, the Advisory reminds FCMs to adhere to certain requirements when holding virtual currency as customer funds, including depositing such virtual currency only with a bank, trust company, another FCM, or with a clearing organization that clears virtual currency futures, options on futures, or cleared swap contracts, and holding the virtual currency under an account name that clearly identifies the funds as customer funds and shows that the funds are segregated. The Advisory also warns FCMs against investing in any segregated futures customer or segregated cleared swap customer funds in virtual currency to be held on behalf of customers.
The Advisory instructs FCMs when designing and maintaining their risk management programs (required under CFTC Regulation 1.11) to limit their acceptance of virtual currency into segregated accounts to particular types of virtual currency that relate solely to trading of futures or options on futures or cleared swaps contracts that provide for physical delivery of those virtual currencies. The Advisory mentions bitcoin and ether as examples.
The Advisory also warns that, notwithstanding the guidance, the DSIO is free to refer to the Division of Enforcement “the FCM’s practices involving virtual currencies, specific transactions involving virtual currencies or related contracts, or for any other reason.”