CFTC Issues Advisory Regarding Virtual Currency Derivatives

Earlier this week, the CFTC published a staff advisory regarding virtual currency derivative product listings. The guidance sets forth five areas of focus for exchanges and clearinghouses in listing a new virtual currency derivatives contract pursuant to Commission Regulation 40.2 or 40.3, including: (1) enhanced market surveillance, (2) coordination with CFTC staff, (3) large trader reporting, (4) outreach to stakeholders, and (5) derivatives clearing organization (“DCO”) risk management.

With respect to prong (1), enhanced market surveillance, the CFTC observed that designated contract markets (“DCMs”) and swap execution facilities (“SEFs”) must establish and maintain an effective oversight program. In reviewing an exchange’s surveillance program, the CFTC stated that staff would assess the exchange’s visibility into the underlying spot markets. Notably, the CFTC stated its belief that a well-designed market surveillance program includes an arrangement to share information with the underlying spot markets, including trade data, and continuous review of relevant data feeds from appropriate spot markets. In addition, the Commission expects that virtual currency contracts are based on spot markets that follow AML and KYC or similar regulations.

With respect to coordinating with CFTC staff, the CFTC conveyed its expectation that exchanges not only engage in regular discussions with the Commission, but that exchanges also provide the CFTC data related to settlements, and coordinate the timing of derivative contract launches to enable the Commission to better monitor trading of newly-listed contracts.

The commission further recommended that exchanges set the large trader reporting threshold for any virtual currency derivative contract at five bitcoin or the equivalent (if the contract is based on other virtual currencies).

Prior to listing new virtual currency contracts, exchanges should solicit comments and views on issues from interested stakeholders. Exchanges should consider including, in any submissions to the CFTC for listing a virtual currency derivative contract, an explanation of substantive opposing views and how the exchange addressed such views or objections. The Commission noted that including as much information as possible will help exchanges to avoid subsequent issues in rolling out the contract.

With respect to the final area of focus, DCO risk management, the CFTC stated that it will review proposed margin requirements and will seek other information relevant to clearing the proposed contract. Such information, the CFTC noted, includes information related to the governance process for approving the proposed contract.

California Considers a New Blockchain-Related Bill

California has taken a conservative step on the path to greater regulation of blockchain technology or legal recognition of blockchain-secured data.  On May 18, an amended bill was referred to the State Assembly Appropriations Committee for review that would provide for the establishment of a blockchain working group to evaluate “the potential uses, risks, and benefits of the use of blockchain technology by state government and California-based businesses.”  The amended bill also provides a legal definition of “blockchain.”[1]

In February, the first version of the bill was introduced by California State Senator Robert Hertzberg before the State’s Senate Banking and Financial Institutions Committee with substantially different contents.  The initial bill would have expanded the definition of “electronic record” and “electronic signature” in the California Uniform Electronic Transactions Act to include records and signatures that are secured through blockchain technology.  It also would have expanded the definition of “contract” in the Act to include a smart contract, as defined,[2] and would have given the same legal effect to blockchain-secured data, including ownership records, as data stored in a traditional database.

In April, the State’s Senate Banking and Financial Institutions Committee then amended and referred the bill to the Judiciary Committee with a “do pass” recommendation.  Notably, all reference to smart contracts was taken away in the amended version.

The bill was further revised to its current formulation by the Judiciary Committee and has been referred to the Assembly Appropriation Committee for further review.  Instead of making the significant step to legally recognize the records and signatures stored on a blockchain, as the bill initially contemplated, the amended bill merely would establish a blockchain working group to evaluate “the potential uses, risks, and benefits of the use of blockchain technology by state government and California-based businesses, on or before July 1, 2020.”  Such blockchain working group would be composed of appointees from a broad range of government and private institutions.   In particular, evaluating the privacy risks associated with the implementation of blockchain technology was singled out as the focus of the working group, which would consist of two appointees representing privacy organizations and two appointees representing consumer organizations, among others.

[1] The bill defines blockchain as “an electronic record of transactions or other data that is (1) uniformly ordered, (2) redundantly maintained or processed by one or more computers or machines to guarantee the consistency or nonrepudiation of the recorded transactions or other data; (3) validated by the use of cryptography.”  See

[2] The initial bill defined smart contract as “an event-driven program that runs on a distributed, decentralized, shared, and replicated ledger that can take custody over, and instruct transfer of, assets on that ledger.”  See

Office of the Comptroller of the Currency Encourages Banks to Meet Consumer’s Needs for Short-Term, Small-Dollar Credit; BCFP Voices Approval

Yesterday, the Office of the Comptroller of the Currency issued a bulletin encouraging national banks and federal savings associations to make short-term, small-dollar installment loans that are both safe and affordable available to consumers.

The bulletin observes that despite the need, many banks have withdrawn from this market, forcing consumers to turn to non-bank lenders. The bulletin encourages banks to fill the gap and sets forth three general lending principles that banks should bear in mind when offering short-term, small-dollar installment lending products:

  • All bank products should be consistent with safe and sound banking, treat customers fairly, and comply with applicable laws and regulations.
  • Banks should effectively manage the risks associated with the products they offer, including credit, operational, compliance, and reputation.
  • All credit products should be underwritten based on reasonable policies and practices, including guidelines governing the amounts borrowed, frequency of borrowing, and repayment requirements.

With respect to the last principle, the bulletin provides further guidance on what constitutes reasonable policies and practices, including but not limited to: loan amounts and repayment terms that align with eligibility and underwriting criteria, fair treatment of loan applicants, and pricing scaled to product risks and costs.

Notably, the OCC also stated that it “views unfavorably an entity that partners with a bank with the sole goal of evading a lower interest rate established under the law of the entity’s licensing state(s).”

Subsequent to this announcement by the OCC, the Acting Director of the Bureau of Consumer Financial Protection, Mick Mulvaney, issued a statement applauding the OCC’s move.

Customer Due Diligence Rule — Key Practical Resources

FinCEN’s Customer Due Diligence Rule for Financial Institutions (the “CDD Rule”) became effective yesterday.  The rule, which was published by FinCEN on May 2016 (and slightly amended on September 29, 2017) is described in this Covington client alert.  It requires covered financial institutions to: (i) adopt due diligence procedures to identify and verify a legal entity customer’s beneficial owners at the time a new account is opened and (ii) establish risk-based procedures for conducting ongoing customer due diligence, including developing customer risk profiles and implementing ongoing monitoring to identify and report suspicious activity and, on a risk basis, updating customer information.

In the months leading up to the CDD Rule’s effective date, FinCEN, the FFIEC and other agencies released a number of documents that provide practical guidance on its implementation.  Those include:

  • Two new sections of the FFIEC’s BSA/AML Examination Manual, which focus on the CDD Rule and were publicly circulated yesterday in the form of an FDIC Financial Institution Letter.  This document will be used by federal bank examiners at the Fed, the OCC, the FDIC and the NCUA to guide their examination and supervision of financial institutions for compliance with the CDD Rule.
  • A FinCEN FAQ document, which was updated last month.  The updated FAQs — which supplement FAQs issued in July 2016 — address questions related to the CDD Rule’s identification and verification requirements and the Rule’s application to legal entity customers with complex ownership structures, among other issues.
  • A Regulatory Notice released by FINRA at the end of last year, which provides guidance on the application of the CDD Rule to broker-dealers.

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Release of 2017 HMDA Data

The Federal Financial Institutions Examination Council (FFIEC) released yesterday data on mortgage lending at institutions covered by the Home Mortgage Disclosure Act (HMDA) — a total of just under 6,000 banks, credit unions and non-bank mortgage lenders.  Concurrently, the Consumer Financial Protection Bureau (CFPB) released a “first look” report on mortgage market activity and trends based on a selection of the newly released data.

As the CFPB points out, this year’s release is notable for two reasons, among others:

  • First, it reflects recent changes to the CFPB’s Regulation C, which generally exempted institutions from HMDA reporting if, in either of the two preceding calendar years, they originated less 25 reportable home purchase loans (including refinancings).  This contributed to a modest 13% decline in the number of participating institutions.  (We previously discussed other aspects of the CFPB’s amendments to Regulation C, including in these posts.)
  • Second, it reflects the first year during which HMDA data will be available in a dynamically updated format through the FFIEC HMDA Platform.

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Australia and Malta Adopt Different Approaches to Cryptocurrency and Blockchain Regulation

The Australian Transaction Reports and Analysis Center (“AUSTRAC”) recently implemented a new regulation for digital currency exchange providers operating in Australia called the Anti-Money Laundering and Counter-Terrorism Financing (Digital Currency Exchange Register) Policy Principles 2018.  AUSTRAC is Australia’s financial intelligence agency and is responsible for the enforcement of Australia’s Anti-Money Laundering and Counter-Terrorism Financing Act (“AML/CTF”).

The new Australian regulation requires any digital currency exchange provider operating in the country to register with AUSTRAC and comply with the AML/CTF requirements.  It is intended to minimize the risk that criminals use cryptocurrencies like bitcoin to conduct money laundering, terrorism financing and cybercrimes.  According to the CEO of AUSTRAC, the regulation “will help strengthen public and consumer confidence in the sector.”

Australia’s regulation, focusing on financial crimes, is less comprehensive than the legal framework being crafted by Malta for cryptocurrencies and blockchain technology, which includes the Malta Digital Innovation Authority Bill, Technology Arrangements and Service Providers Bill, and the Virtual Currencies Bill.  Malta aims to position itself as the “natural destination” for businesses that operate in the blockchain space, according to Silvio Schembri, the Junior Minister for Financial Services in the Office of the Prime Minister of Malta.

Bureau of Consumer Financial Protection Amends Timing Provisions of Federal “Know Before You Owe” Rule

On April 26, 2018, the Bureau of Consumer Financial Protection (the “Bureau”) finalized an amendment to the “Know Before You Owe” mortgage disclosure rule (also known as the TILA-RESPA Rule), which it proposed in July 2017 and which we previously described in this blog. The amendment eliminates uncertainty regarding a timing restriction in the TILA-RESPA Rule, specifically whether and when a creditor may use a Closing Disclosure to communicate increased closing costs charged to consumers.

The TILA-RESPA Rule requires a creditor to provide a good faith estimate of loan terms and closing costs on a Loan Estimate, which must be delivered or placed in the mail to a consumer no later than three business days after the consumer submits a loan application. In certain circumstances, the creditor may use a revised estimate, as opposed to the estimate originally disclosed, as the good faith estimate. If the creditor uses a revised estimate, the creditor must provide the consumer with a new Loan Estimate reflecting the revised closing costs within three days of receiving information that prompts the revised estimate.

The existing TILA-RESPA Rule contained restrictions on the timing of providing a Loan Estimate: (i) the consumer must receive any revised Loan Estimate no later than four business days prior to consummation; and (ii) the creditor cannot provide a revised Loan Estimate on or after the date it provides the Closing Disclosure to the consumer, which must be at least three business days prior to consummation. However, if there were less than four days between the time the revised estimate is required to be disclosed and consummation, then the TILA-RESPA Rule provided that the creditor could include the revised closing cost estimates in the Closing Disclosure.

These restrictions created a “black hole” period during which a creditor could learn of closing costs not initially disclosed on a Loan Estimate that could be included in a revised estimate, but would be unable to provide a revised estimate on either a Loan Estimate or Closing Disclosure. For example, under the existing TILA-RESPA Rule, if a creditor provided the Closing Disclosure to the consumer and an event subsequently occurred that caused an increase in closing costs, the creditor could not disclose such costs on a revised Loan Estimate. Moreover, the existing TILA-RESPA Rule did not specify whether a creditor could revise the Closing Statement to reflect the newly incurred costs if there were more than four business days between the time the creditor was supposed to provide the revised version of the disclosures and consummation.

The Bureau’s April 26, 2018 final rule specifically provides that a creditor may use a Closing Disclosure, instead of a Loan Estimate, to reflect changes in closing costs for the purpose of determining whether an estimated closing cost was disclosed in good faith, regardless of when the Closing Disclosure is provided relative to consummation. The final rule is generally consistent with the July 2017 proposed rule.

The final rule will go into effect 30 days after publication in the Federal Register.

Cboe Contributes to Ongoing Discussion Regarding Cryptocurrency ETPs

Last month, Cboe Global Markets, Inc. (“Cboe”) responded to a staff letter on cryptocurrency funds and related investment products published by the SEC earlier this year.

The SEC staff letter recognized that proponents of cryptocurrencies have identified a range of potential benefits and that innovation is important, but the SEC also identified a number of risks associated with such investment products and raised a number of questions regarding how such assets would satisfy the ‘40 Act and its rules. The SEC’s letter invited interested sponsors to engage with the SEC in detail on these issues.

Cboe’s response to that letter specifically encourages the SEC to permit cryptocurrency exchange-traded products (“ETPs”). Cboe discussed the SEC’s concerns, and concluded that while cryptocurrency holdings do present some unique issues, many of the risks associated with cryptocurrency ETPs could be addressed within the existing framework for other commodity-related funds. Cboe added that, where it could be reasonable for an investment portfolio to provide exposure to cryptocurrency, an ETP would provide a more transparent and accessible vehicle to gain such exposure. Cboe concluded that, in light of that fact, where the market and infrastructure for the underlying asset and its derivatives do not cause significant concerns regarding the issues raised in the Staff letter, “the Commission should not stand in the way of such ETPs coming to market.”

SEC Proposal Dives Into Long-Standing Debate About the Duties of Investment Professionals

On Wednesday, April 18th, the SEC introduced a much-anticipated package of proposed rules and formal guidance concerning the standards of conduct for financial professionals. The more than 1,000-page proposal, which emerged eight years after Congress required the agency to conduct a study on the topic, addresses whether investment advisers and broker-dealers should have identical or different standards of conduct vis-à-vis their retail customers. This alert takes a look at the four key parts of the SEC’s proposal.

Read the full alert here.

FSOC to Consider First Case Under Dodd-Frank’s Hotel California Provision

The Financial Stability Oversight Council (“FSOC”) has announced that on Thursday, April 12, 2018, it will consider a “potential application” from a bank holding company or its successor to be de-designated as a systemically important financial institution under section 117 of the Dodd-Frank Act.

Sometimes known as the “Hotel California” provision,[1] section 117 of Dodd-Frank provides that any institution that was a bank holding company with $50 billion or more in total consolidated assets as of January 1, 2010, participated in the Capital Purchase Program of the Troubled Asset Relief Program, and ceases to be a bank holding company, will presumptively be treated as a nonbank systemically important financial institution (“nonbank SIFI”) and continue to be supervised and regulated by the Federal Reserve.  Such an institution may appeal its designation as a nonbank SIFI to FSOC, which may grant the appeal by a vote of two-thirds or more of its voting members, including an affirmative vote by the Chairperson (the Secretary of the Treasury).

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