On December 15, 2017, the U.S. Commodity Futures Trading Commission (the “CFTC”) issued a proposed interpretation of the term “actual delivery” as used in the provision of the Commodity Exchange Act (the “CEA”) that grants the CFTC explicit authority to oversee the marketplace for “retail commodity transactions”. This is the first blog posting in a multi-part series that will explore the regulation of retail commodity transactions and the CFTC’s recent proposed interpretation (the “Proposed Interpretation”), the issuance of which we believe has represents a potentially significant milestone in the regulation of virtual currency transactions. We begin our series with a brief look at the history and background of the regulation of retail commodity transactions.
The CFTC has exclusive jurisdiction over the marketplace for “retail commodity transactions,” arrangements that Section 2(c)(2)(D) of the CEA describes as an agreement, contract or transaction that is offered or entered into by a party:
- on a leveraged or margined basis, or financed by the offeror, the counterparty, or a person acting in concert with the offeror or counterparty on a similar basis; and
- to or with persons who do not qualify as either an eligible contract participant (“ECP”) or an eligible commercial entity (“ECE”).
Note: The definitions of ECP and ECE are found in Section 1a(18) and 1a(17) of the CEA, respectively. In short, an ECP must be a type of regulated entity (such as a financial institution), or satisfy certain financial qualification tests, while an ECE is a sub-set of ECPs that use a commodity for the commercial purposes specified in the CEA. An ECP can be either an entity or a natural person.
Section 2(c)(2)(D) was added to the CEA in 2010. Although technically part of the Dodd-Frank Act, the regulation of retail commodity transactions is a chapter of regulatory history that pre-dates the systemic risk concerns that underpinned many of the other more well-known regulatory initiatives that followed on the heels of the Lehman / AIG / market crises of 2008, and subsequent standards for the derivatives markets adopted at the 2009 G-20 Pittsburgh Summit. In particular, Section 2(c)(2) of the CEA was amended in order to address perceived, and in some cases actual, fraud in the retail currency and commodity markets, and more generally to bring a heightened level of regulatory oversight to those markets. In short, Congress revised the CEA in direct response to certain judicial decisions (the most notable of which was CFTC v. Zelener, 7th Circuit 1994) that hampered the ability of the CFTC to oversee these retail markets.
The regulatory principle behind the CFTC’s oversight of retail commodity transactions is that such arrangements are speculative in nature and have indicia of futures contracts by virtue of the use of leverage, margining or financing. When viewed through that lens, it makes sense that the proposed interpretation would have been issued in the days following the commencement of trading in bitcoin futures contracts.
If an arrangement constitutes a retail commodity transaction, then it is subject to the same regulatory standards and requirements as a futures contract (which in the language of the CEA is called a “contract of sale of a commodity for future delivery”). In effect, a retail commodity transaction must be entered into over a CFTC-regulated futures exchange (which in the language of the CEA is called a “designated contract market”). At the present time, no futures exchange lists any retail commodity contracts nor, to our knowledge, has any exchange indicated its intentions (at least publicly) to facilitate leveraged commodity trading on a retail basis.
Significantly, not every arrangement that involves the leveraged, margined or financed purchase or sale of a commodity will be regulated as a retail commodity transaction. In particular, Section 2(c)(2)(D)(ii)(III) of the CEA excepts two types of transactions:
- A contract of sale that results in actual delivery within 28 days; and
- A contract of sale that creates an enforceable obligation to deliver between a seller and a buyer that have the ability to deliver and accept delivery, respectively, in connection with the line of business of the seller and the buyer.
The December 15th Proposed Interpretation focused on the first of these two exceptions, but is not the first time that the CFTC has issued an interpretation in respect of the “actual delivery” exception. In 2013, the CFTC issued an interpretation of the actual delivery exception in the context of certain physical commodity transactions. However, the 2013 guidance was not particularly well-suited to virtual currency transactions. In its own words, the CFTC issued the Proposed Interpretation –
…to inform the public of the [CFTC’s] views as to the meaning of the term “actual delivery…and to provide the public with guidance on how the CFTC intends to assess whether any given retail commodity transaction in virtual currency results in actual delivery.
The Proposed Interpretation provides examples of actual delivery. The CFTC has also raised several questions, and invited the public to comment on its Proposed Interpretation. Comments are due 90 days after the Proposed Interpretation is published in the Federal Register, which should occur before the end of the year (and most likely during the week of December 17th).
Our next posting will focus on the Proposed Interpretation, as well as the examples of actual delivery provided therein. In a subsequent posting, we will provide observations in respect of some “practical” considerations relating to custodial and transactional practices in the existing retail commodity markets, particularly in light of the specific questions raised by the CFTC.
Good day. Good background? We hope and more to come. DR2