RegFi Episode 80: The Clarity Act and the Future of Digital Asset Regulation
25 min listen
In this follow-up conversation, RegFi co-hosts Jerry Buckley and Sasha Leonhardt welcome back Dan Ullman, Orrick partner and former CFTC Chief Trial Attorney, to unpack Congress’s most consequential digital-asset proposal to date: the Clarity Act.
Building on last week’s discussion of the CFTC’s agenda, Dan breaks down how the Clarity Act would establish the first comprehensive federal regulatory structure for digital assets — shifting most oversight to the CFTC, reshaping the agency’s mandate and setting in motion an extensive rulemaking effort reminiscent of the post–Dodd-Frank swaps regime.
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Jerry Buckley:
Hello, this is Jerry Buckley, and I'm here with RegFi co-host Sasha Leonhardt. We are joined today by our partner, Dan Ullman.
Dan was our guest last week to talk about what's happening at the Commodity Futures Trading Commission, or the CFTC, where he served as Associate Director and Chief Trial Attorney before joining Orrick. When we asked Dan to be our RegFi podcast guest, we realized that reviewing all that is going on at the CFTC and discussing the content and legislative status of the CLARITY Act all in one episode just wouldn't work, so we asked Dan to come back and discuss the CLARITY Act and related legislation today.
In previous RegFi episodes, we've discussed the GENIUS Act, which deals with the blockchain-enabled stablecoins. The CLARITY Act, now being debated in the Congress, deals with the regulation of other forms of blockchain-enabled transactions. Let's start out by noting that the CLARITY Act is the informal title of a bill passed by the House of Representatives in July. That bill has been sent to the Senate and is under consideration in two Senate committees: the Senate Agriculture Committee and the Senate Banking Committee.
Dan, would you set the table by explaining the purpose of the CLARITY Act, including just what activities this proposed legislation covers, and why the legislation is deemed necessary?Dan Ullman: Thanks, Jerry. And thanks for that nice introduction. Glad to be back. The people have spoken, and so here's episode two. I think that the way to think about the CLARITY Act — the most significant and important piece of financial legislation since Dodd-Frank. It sets forth a comprehensive regulatory structure for digital assets on the transaction of digital assets. And it grants the vast majority of jurisdiction under this new legislation to the Commodity Futures Trading Commission and not the SEC. And it's important to understand that this creates entirely new — and imposes on market participants and intermediaries an entirely new — top-down regulation scheme, to be extremely similar to what happened when swaps were regulated under Dodd-Frank. Jerry: Sasha, why don't we draw you into this? Sasha Leonhardt: Dan, welcome back, and thanks for coming back for an encore presentation. This year, it's no secret that crypto and crypto-related legislation has moved up on the congressional priority list, and we're seeing it on the administration's broader agenda as well. What's driving this push in the crypto space? Dan: It's a really, really interesting question. This bill, I think, is a rare example of the government and the private sector agreeing that something needs to be done. The private sector wants some type of clarity, pun intended, about digital assets. What are the rules? What government agency is overseeing these? What do corporations have to do to comply with the law? Who needs to get registered? Very simple questions if you're transacting in what is becoming more popular: digital currency.
Parts of the government, parts of the Senate, want some level of regulatory control over these assets. Now, I know that your listeners and you on this podcast have been dealing with digital currency. I have now for ten or 11 years. But most people, and a lot of people in the Senate, consider these to be new and novel products that pose dangers — similar to other types of derivatives — to the inherent health of the economy overall. Other people understand that there has to be some level of consumer protection for digital assets, which is debatable whether that exists at all right now. And if it does, it's through a patchwork of different state legislation actions and the federal government. And so, what the industry also thinks about this is that once the bill is passed — that this is going to unlock mass acceptance of digital currency and make digital currency more popular, which, in turn, should make profits higher for everybody. So basically, every stakeholder in this is interested in getting some bill passed that actually lays out the law for all types of digital currency, which does not exist right now.Sasha: And, as Jerry mentioned, the CLARITY Act has been referred to two different Senate committees. We've got the Banking Committee, with jurisdiction over the SEC, and the Agriculture Committee, which has jurisdiction over the CFTC. Now, we're obviously in the middle of the legislative process now, but the House-passed bill would place more responsibility for crypto with, as you noted, the CFTC. If the current draft we're kind of looking at is enacted, signed into law, what would this mean for the CFTC? How would it impact the agency's agenda? What staffing would be needed? How would it transform the agency from what you think of it as today? Dan: Well, I think the closest analog in time and in substance is what happened in Dodd-Frank for swaps. Now, everyone listening to the podcast understands that one of the contributing causes of the financial crisis in 2008 and 2009 were swaps — and the fact that swaps were not cleared and that swaps had significant counterparty risk and counterparty risk multiplied exponentially forever. So, after Dodd-Frank was passed, the commission, the CFTC itself, I think, passed over ten rules, and a major — a lot of the rules had to do with swaps. And basically, the rulemaking for swaps created registration categories for intermediaries dealing with swaps, rules about swaps in the Commodity Exchange Act, and a reporting structure — where swap dealers would be compelled to issue information about what swaps they were holding, what the values of the swaps were — to make sure that there were no systemic time bombs in people's swap holdings and who had it. So, if the CLARITY Act passes, or in the current version of the Ag Committee, that's going mean that there's going be significant rulemaking in the CFTC.
And that's really where the rubber hit the road. If you talk to intermediaries currently that transact in swaps, they will tell you that they believe that the rulemaking for swaps is too onerous — that the rules that are not necessarily in Dodd-Frank itself, but that CFTC rules that are interpreting swaps can be onerous. They may be outdated. And clearly, if the CLARITY Act passes — it's the likelihood that it's going to be — there is going to be a lot of time and energy spent commenting on the potential rules for cryptocurrency and lots of commission action.
The question you have about the CFTC staffing is really smart as well because the latest version of the CLARITY Act — you can tell Congress is concerned about two things — actually, three things about the commission. One, they are concerned about having one commissioner. And, as we discussed last time, the CFTC, now for about a year, has had one acting chairman and no other. And for the last six months, no other commissioners. So, in the text, the bipartisan markup of the CLARITY Act, there are edits that ask for a fully constituted commission. There are also proposed changes that indicate that they want to make sure the CFTC is staffed correctly. And, I think, for the first for the CFTC is an earmark to make sure the CFTC has at least $150 million of extra budgetary funding to make sure that it has enough staff to be able to implement the rules of digital currency, and I think that is a callback to consumer groups being concerned that there is some type of consumer protection for entities that are transacting in digital currency.Jerry: You know, your reference to the budget just brings up a thought in my mind. The FDIC, for instance, is funded by fees paid by the banks that are part of it. The Office of the Comptroller of the Currency is fully funded by fees paid by the regulated entities. What contribution do the regulatees of the CFTC make to the budget of the agency? Dan: The answer is 0.0. The CFTC is the only, I believe, federal regulatory agency that receives no sort of transactional fees for any type of trading. And that — in the markup of the CLARITY Act, there is an edit that actually asks for some type of funding mechanism through trading. Now, this is a big deal in derivatives in particular because most of the orders on derivatives are algorithmically made. And when I started at the Commission, we would measure trades in milliseconds, and now, it's in microseconds. So, literally, on heavily traded derivatives, in a second, there can be a billion orders that are placed. So, transactional fees in this space is a very sensitive subject. And again, different than the SEC, like we talked about in the last episode. So, that is a significant issue, and I suspect some turbulence from the larger designated contract markets, the exchanges, on this point particularly. Jerry: Right, right. Dan: Great question. Jerry: You know, the Senate Banking Committee has its own version of legislation titled the Responsible Financial Innovation Act, or the RFIA, that lodges more regulatory responsibilities with the SEC. Could you describe the differences in approach between the two committees? Dan: Yes. Last episode, we talked a little bit about how both the SEC and the CFTC started and how they had different objectives and started with different interest groups and actually, frankly, different parts of the country, with the SEC really being sort of an East Coast, Northeast-centered agency, whereas the CFTC was really in the Midwest and focused in Chicago. And as these products have converged, especially over the last 15 years, both agencies have overlapped, frankly, on their jurisdiction over digital currency.
And right now, it is sometimes very difficult to discern what law applies or do both the SEC and the CFTC have jurisdiction over certain products. So, it is understandable and, frankly, predictable that the Ag Committee, which oversees the SEC — or, sorry, the CFTC — the Ag Committee oversees the CFTC — and the Banking Committee, which oversees the SEC, would have different ideas about digital currency. And the RFIA gives the SEC more jurisdiction over these products than the CLARITY Act — again, I think understandably — and uses some common law tools about to figure out whether digital currency falls under the ambit of the SEC or the CFTC, the famous Howey test that everyone will be happy to discuss with you — that's dealing with securities or digital assets. So, you know, I think that the SEC also has broader exemptions than the CLARITY Act has. Both the Commodity Exchange Act and the Securities Act have exemptions — the certain amount of time where you don't have to necessarily be registered, certain transactions. At least the current version of RFIA, it seems to be slightly more generous about exempting certain transactions than the CLARITY Act does. But, again, I think, this is — and Jerry as a veteran of the Hill, you know this — like, I think this is more kind of the political reality of having two competing committees in this space. And we'll see how it's going to be resolved. It seems, at least for me, from my read, that the CLARITY Act has a leg up from the RFIA, but we'll see what happens.Sasha: Obviously, Dan, a bill like this is going to have a lot of people weighing in. Can you talk a little bit about which crypto advocacy groups are, in fact, coming to the table here? And what are they saying with respect to the CLARITY Act and these issues more broadly? Dan: Yeah, I think to answer this question, we have to think about industry and how will they perceive the SEC under Gary Gensler under the last administration. And, I think it's safe to say that most digital asset market participants believe that the SEC under Gary Gensler was too aggressive and sort of tried to strangle the baby in the crib about innovation, or cryptocurrency. There is strong feelings from the industry that that is a mistake, that that has hindered American innovation in the space, and has put us at a competitive disadvantage compared to other countries about digital currency. And so, it is extremely clear that industry groups want to get this passed, and they want to make sure that there is some framework, some fairness, about how they should behave in this environment. And part of that is that, I think, a lot of industry groups want to steer this away from the SEC and steer it toward the CFTC, which institutionally as a building tends to be more industry favorable than the SEC has, with the noble exception of being the enforcement division, which I think has been traditionally equally as aggressive. But the building itself is, I think — partially due to the complexity of the products that the CFTC oversees — has traditionally been more industry friendly. So, I think that most industry participants want to have a bill that's passed that creates some type of clarity in this space, but second, also tries to give jurisdiction for this to the CFTC as opposed to the SEC.
Now, that's sort of what's going on from private industry. There are — Better Markets, in particular, which is a sort of left-wing pressure group on consumer protections, has been critical about what the CLARITY Act contains and is concerned about its consumer protections, which is understandable from that group. I think that one thing to keep in mind, also, is — that it's often overlooked: Not only is the Commodity Exchange Act a criminal statute, but it also has a private right of action. Okay? So, if there's a market manipulation, there is a part of the act that allows individuals to bring private causes of action. One thing, I think, that's been overlooked in this conversation — and we'll see what the final third act looks like — is that this essentially is going to make the Commodity Exchange Act a consumer statute, where because of the relative lack of day trading on futures, now consumers are trading and dealing with digital currency every day. So, I think that it's likely to turn the Commodity Exchange Act into a consumer act, which is something that all of our clients and businesses need to think very carefully about.
That's a long way of saying that I think that there are valid criticisms to be made about consumer protections in both of these bills, but I think one thing overlooked by everybody is the power of private right of actions under the Commodity Exchange Act for any type of misfeasance or malfeasance that happens under the act itself.Jerry: You know, that's a very interesting observation coming from the former Chief Trial Attorney at the agency. You have your finger on that pulse probably more than anybody, Dan. Dan, you didn't mention, but one of the — you mentioned the consumer advocacy, but who are the groups that are primarily behind the push to get the CLARITY Act through on the industry side? Dan: The list is almost too long to name. I think it's fair to say that most interest groups — and again, I don't have a list in front of me — but most interest groups are extremely interested in getting this bill passed, or something passed. And you could understand why because if you're sitting there and you want to deal with digital currency, it's difficult enough to have one regulator, but to have two regulators and potentially, I don't know, Treasury throws in or that's through, and it may be almost impossible to comply with the law if you don't know what it is. Jerry: It does help to know what the law is. It's so funny because we all sort of — you'll hear the, "Oh, we're over-regulating; we're over-regulating." And yet, in financial markets, if you don't have regulation, you've got chaos. So, you know, it's a tough balance, isn't it? Dan: It does help to know what the law is. It's so funny because we all sort of — you'll hear the, "Oh, we're over-regulating; we're over-regulating." And yet, in financial markets, if you don't have regulation, you've got chaos. So, you know, it's a tough balance, isn't it? Jerry: Right. Dan: It's clear that we're at an inflection point. Digital assets are becoming more popular every day. If you watch television now — if you watch a football game, you're going to see 55 advertisements for it. I mean, this is an example where I think the government can hopefully help the economy by providing some type of regulatory clarity to these products. Jerry: You know, I'll offer kind of a cautionary note. Assuming that the two committees are able to come together on a mutually agreed upon bill, it'd be necessary to get some Senate floor time. The Senate already has a number of items on its agenda for this month, with the Christmas recess coming up, and whether it's the funding bills or how we're going to deal with the health care subsidies — all very controversial. So, there are many that think that it's unlikely that this is going to move ahead, even, you know, at any level of the floor before the Christmas recess. And it should be noted that there are skeptics on the Senate Banking Committee, you know, who are — you've referenced the advocacy groups, but of course, Senator Warren may wind up trying to put a hold on the bill. And in light of these factors, there are a number of people I've talked to who believe that the CLARITY Act is not a foregone conclusion. What are you hearing, Dan? Dan: Yeah — no — I mean, I think it's extremely hard to predict what the Senate is going to do about this. What I hear from my sources is that there is momentum behind the bill. I think it's extremely unlikely that it's going to get passed this calendar year. But what I've heard from two or three sources and also some people in the industry from their legislative affairs groups is that early spring seems to be the target date that people think it's going to pass. Again, we'll see. I'm not a prediction market myself, so very difficult to figure out what's going on. Jerry: Well, that is an interesting question and one I wanted to ask you. We talked last time about prediction markets. Have the prediction markets weighed in on the prospects that the CLARITY Act will pass, or some version of it? Dan: I haven't heard anything official from prediction markets, but I think that in — you know, some prediction markets are — you know, wouldn't really have anything to do with, or little to do, with digital currency. It would be more like traditional TradFi. But yeah — no, I haven't heard anything about what's specifically going on. Jerry: You can bet on anything — you know, what's the — how many points are going to be scored in this quarter and so forth. So wouldn't it be expected that in something so important to the blockchain industry as the CLARITY Act, there might be a predictions market? Dan: You know, we shouldn't rush to judgment. I'm going to give a look after this podcast and see if we can see if there is one because it seems like you can — that there's a prediction market, an event contract, for basically anything these days. You're right. Jerry: Exactly. Exactly. Dan: Yeah, totally right. Jerry: We'll have to look at that. We should looked at it before we started our podcast. Dan: I wouldn't that there is, but we'll see. Jerry: Right. You know, of course, if legislation does pass, as you've mentioned, we're going to be into a rulemaking process, and businesses are going to have to be given some time to set up compliance regimes. How long do you think it will take after passage for regulations to be put in place? And any thoughts about what businesses should be preparing for now in terms of putting compliance policies and procedures in place, or at least starting to think about it? What would you advise people? Dan: Yeah, I think that the provisions of Dodd-Frank were given basically a year and a half to two years before they were implemented after passage. So, I think it was in late summer of 2011, and I think the bill passed 2009 or 2010. So, there's that. The rules are going to take longer because they have to file the APA, and, especially for the CFTC, these issues are going to loom so large that there are going to be big hearings about this, tons of comment letters. So, I think that process can take an additional year. So, my guess is that maybe two to three years after it's passed, the full regime will be in play for entities.
I think it's important for companies, any type of financial company, to pay attention to what's going on with the CLARITY Act and where it is in the Senate. The second issue is that there are tons of companies that right now aren't registered at all that are going to have to take steps if the CLARITY Act passes, or RFIA passes, where suddenly to transact in these businesses, they are going to have to register with the CFTC. They're going to have to understand the entire CFTC compliance scheme, which is difficult and complicated. And along with that are the regs, which the regs are really, again, where the rubber hits the road about how to comply with the law. So, it's going to require essentially expertise in the Commodity Exchange Act, which before now has been really limited to classic derivatives and swaps. So, the Commodity Exchange Act continues to grow, and companies are going to have to make sure they understand what they need to do over that.Jerry: So, great opportunities for people with your high level of expertise. You know, may I just ask a question that strikes me both with respect to AI regulation and in this space, the blockchain, and the overlapping space? When I worked on the E-Sign Act back, you know, 25 years ago, the act was passed as a simple statute with no call for regulatory agencies to call out the answers because the fear was that the regulation would stifle innovation. But of course, in the financial services spaces, and the reason why we're talking about the CLARITY Act, is you need some guidance in order to know, you know, what should I do and how do I avoid problems, generic problems like UDAP problems or other challenges by states or federal agencies? So, it's a tough thing to strike the balance, it seems to me, between regulation and space or breathing room for innovation. And so, this regulatory process is going to be fascinating to watch. And as you say, there are so many people who will become registrants who haven't been in a regulated space before. So, I'd be interested in your thoughts about how regulation fights with innovation. Dan: Yeah, I mean, I think it's a constant tension, and it's a constant tension in this country, which is the world leader in economics and finance, and, I think, probably currently in digital currency innovation. Yeah, it's a constant tension. I think that the difference with this bill is what you just articulated, Jerry. That when Dodd-Frank passed, everyone dealing in swap contracts that previously was either ungoverned or certainly was not registered was a major financial institution that understood — and it was probably a broker-dealer or probably a futures commission merchant — understood that the company itself, kind of as a raison d'etre of the company, would be registered with a government. Jerry: Right. They swam in regulatory waters. They were already familiar with it. Yes. Dan: Exactly. And especially if they were related to banks, which most of them were. So, this was not something that was shocking. Okay? But all of the entities transacting — okay, except for the consumer and end user. But if you have an exchange that's dealing with digital currency, if you are a broker that's engaging in the sales of digital currency, all of a sudden, you know, the Commodity Exchange Act — which too bad we're on a podcast, I would show you how thick it is — is going to be your new Bible about how to do business. Jerry: Uh-huh. Dan: And that is something to be very careful about because it's a wide-reaching law, and it's really only applied to a very small group of people so far, a relatively small group of people. This is going to dramatically increase the ambit of not only the Commission itself, but the Commodity Exchange Act and regs. Jerry: Fascinating. Well, it is going to be extraordinarily interesting to see — first of all, what happens in the legislative context, what gets changed, how they resolve the differences between the Senate Banking Committee and the Agriculture Committee of the House version of the bill. A lot to happen. We're going to have to have you back again, but we'll give you a month or two off to do a few other things. And we really want to thank you, Dan, for being with us today. And, you know, I know you've got a lot going on and making the time to do this podcast. I think it'll be very interesting to our listeners, and we really appreciate it. Dan: Oh, me too. I'm thrilled. And thanks again for having me back. I really appreciate it. Sasha: Thank you, Dan.