Comment Text:
I strongly endorse Chairman Christy Romero's viewpoint as expressed in her comment, accessible through the following link: https://www.cftc.gov/PressRoom/SpeechesTestimony/romerostatement062823
The idea of integrating clearinghouses with customer-facing intermediaries in a vertical manner raises significant concerns regarding market stability, investor safeguarding, and the reduction of market risks. I firmly believe that this proposed regulatory framework should not be adopted under any circumstances. It essentially cedes substantial risk and leverage to a vertically integrated clearinghouse, akin to a monopoly, while concurrently diminishing both the visibility of risk and the presence of a naturally occurring corrective mechanism.
I want to underscore Chairman Romero's insightful statement: "Our clearinghouse rules were not designed to protect customers, as they were created with the assumption of a distinct intermediary interacting with customers and bearing regulatory responsibilities for safeguarding them."
With the intermediary now being phased out, the existing regulatory rules for clearinghouses offer reduced customer protection, paving the way for potential investor exploitation due to the lack of oversight and protective measures. Investor confidence in the market, a crucial element for its proper functioning, is eroded without adequate regulatory scrutiny and consumer protection. It's clear that clearinghouses are no longer primarily oriented toward customer and investor welfare.
In this new landscape, investor interests can no longer be assured during trade execution. Competition dwindles, regulatory oversight diminishes, and clearinghouses are no longer obliged to adhere to equitable trade execution practices.
Chairman Romero's subsequent comment highlights how vertical integration stifles competition. Investors are no longer shielded by the regulatory checks placed on clearinghouses for this purpose, and the consolidation of power into a single entity negates the market's self-regulatory potential. This concern is elaborated upon in her comment as follows:
"The traditional market structure has built-in checks and balances—market discipline stemming from divergent interests of various entities—that promote financial stability. Transitioning to a novel vertically integrated market structure for clearinghouses, for instance, raises specific concerns because the resilience of our clearing system depends significantly on the disciplining effect exerted by clearing members on clearinghouses. Clearing members may be called upon to share losses and accept risks in a default scenario, so they have a vested interest in the decisions made by clearinghouses. Their perspective may differ, and their interests may not align perfectly with those of the clearinghouses. What happens to this disciplining effect when the clearing member (the futures commission merchant (FCM)) is owned by the same parent company as the clearinghouse?"
The answer is clear: there will be no disciplining effect, and the accepted risks and potential losses will be dictated by the new clearinghouse monopoly. External entities will have no authority to intervene or set risk limits, resulting in unchecked risk accumulation. This scenario is reminiscent of the problems observed in the novel credit default swaps and mortgage-backed securities markets, where risks were poorly understood and virtually unregulated. It is vital that we learn from history, particularly the 2008 financial crisis, which was exacerbated by insufficient regulation. Although this new vertically integrated clearinghouse environment is not analogous to a poorly packaged security, the lack of insight into its risks, the unchecked risk-taking, absence of corrective feedback loops, and competition-free landscape all combine to create a potentially hazardous market environment.
Another noteworthy point from Chairman Romero's comment is her observation: "Notably absent from this request for comment is a discussion of vertical integration in the context of crypto platforms. This market structure has garnered significant attention in that arena, as many crypto companies are vertically integrated within an unregulated space. Appropriate regulation should not mean simply transplanting an unregulated market structure into regulated markets."
This is a critical concern. The proposed regulatory changes seem to mirror the market structure of the unregulated crypto space, which offers considerably fewer protections for investors. The example of FTX, which was involved in fraudulent activities, illustrates the risks inherent in adopting the market structure of an unregulated space that has experienced significant misconduct.
Chairman Romero also noted the following in a speech before the fall of FTX: "Crypto-related companies often assume multiple roles that in traditional finance are divided among different entities. An exchange may also function as a market maker, clearinghouse, lender, and custodian. These conflicts of interest pose substantial risks that would be disclosed and managed in a regulated environment. In an unregulated environment, the full extent of these conflicts may remain hidden, potentially leading to escalating losses and contagion risks."
It is striking that the risks highlighted in her speech materialized in the case of Binance. Now, we are contemplating changes to our regulatory structure that would emulate Binance's market structure, even though it has exhibited significant risks. Given the nature of the commodities market, the potential for escalating losses and contagion risks is considerably higher.
Chairman Romero testified before Congress in 2009, addressing the 2008 financial crisis: "In my Congressional testimony, I cited then-Treasury Secretary Timothy Geithner, who informed Congress on June 18, 2009, that the emergence of new financial instruments 'that were almost entirely outside of the Government’s supervisory framework left regulators largely blind to emerging dangers.' The same could hold true for a vertically integrated market structure. Without insight into the risks, we would be largely unaware of emerging threats to customers and financial stability. Public feedback can help shed light on these issues. Nonetheless, we may still lack insight into unregulated affiliates."
The proposed vertically integrated market structure introduces additional risks into the market, decreases regulatory oversight, and reduces visibility and reporting from consolidated clearinghouses. As history has shown, as detailed in my comments, any opportunity for increased profitability through risk-taking will likely be seized. This vertical integration presents added risks without commensurate benefits.
In conclusion, I strongly oppose the implementation of this new regulatory proposal in any form. It appears to empower clearinghouses at the expense of competition and the safety of investors and customers. It could lead to greater profits for clearinghouses at the cost of increased risk, contagion, and cascading losses that will ultimately burden investors and customers.
Thank you.
