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- [00:01]
A
So the CME has sued the CFTC over perpetuals, which is the incumbent suing its own regulator. So the CME filed on June 18th the D.C. district Court to undo the CFTC's approval of U.S. perpetual futures. It's challenging the May 29th order. Green lighting call. She's BTC perp naming the agency and Chairman Mike Selig who the CME says, quote, circumvented the regulatory regime. The CFTC had approved Kalshi's Bitcoin perpetual with a policy statement letting exchanges self certify similar crypto perps as futures without prior review. And the CME says these perps are swaps, not futures. And approving them as futures was arbitrary and capricious Under Dodd Frank. This is Terry Duffy. Under Dodd Frank, it clearly defines what a swap is, of what a future is. And when there's two parties exchanging payments to each other, that is defined as a swap. Now, I have a lot of things to say here, but Chris, I'm going to throw the ball to you first because I'm sure you have a few thoughts, so.
- [01:14]
B
Oh, there's a lot of history here, Austin. Terry Duffy, who I testified in Congress many years ago, I don't know, many. Three years ago, something like that. He didn't like perpetuals and he doesn't like them now. We tried to set the stage for changes to market structure that would enable them specifically around, like not needing an intermediary as much anymore. And he vociferously pushed back and he said some mean things to me at the time, but we can leave that to one side. But if you go back to the history of Dodd Frank, I think the policymakers got this whole idea wrong. I'll walk you through the history and then why I think it's messed up. So we had issues and by the way, like back in the day, banks were innovating all the time. Post Dodd Frank, we really saw very little innovation across the derivatives front. But now we're seeing it again. We're seeing perpetuals, we're seeing prediction markets. So you're seeing these green shoots of innovation again. And of course the incumbents don't like it. But after the global financial crisis, we had this huge issue with what we call derivatives or swaps. And There was the G20 conference in Pittsburgh in 2009. All the governments were like, guys, your derivatives are out of control. These things we call swaps, we want you to report them to a central repository so we can see them. We want you to centrally clear them. We're going to put these entities, we're going to put all this capital in there and we're going to make you face the central entities and then we're going to want you to electronically execute them so we can see it all. And so their policy response to these issues with derivatives was hyper centralization because we didn't have blockchain back then. And what I think they got wrong was they said if an instrument is a swap, you have to hold a certain amount of collateral against it. And they were very prescriptive. It was a five day margin period of risk. And let me explain what this means. If I call the swap, I have to make sure that the margin withstands five days of stresses and the stresses are calibrated. Now why would it be five days? Well, because you need to hold that margin, that collateral based on the liquidity, how fast you can liquidate a defaulter. And the fact is we had really slow operations. We still do to this day. If you have a long weekend, that's three days right there. You know, somebody does a trade on a Friday or even a Thursday, you lose. You know, if it was Juneteenth, Friday, Saturday, Sunday, this, this year, you're three days out. And so if the product's a little bit less liquid, maybe it is concentrated, you couldn't liquidate it. So if you call something a swap, it's five days. Futures are one to two days with the lower, what we call confidence interval, so less margin. And I don't want to get too technical, but it's more than two times if you look at the square root of time and the collateralization. But forget that for now. The problem with this whole idea is that we have some very, very liquid swaps and we have some very illiquid futures. And so from a principles based perspective, you should really collateralize something not by what it's called, but by the properties that it has. But for some reason we got that wrong. And now as we move forward, what the CME is saying is we're saying, wait a second, these things, they're not futures, they're swaps. So you have to hold more cap, you have to hold more collateral against them. The whole idea behind this is to lower leverage. And we say this many times in the show, what do retail like? They like yield and they like leverage. And so if you really constrain the leverage onshore, and you say American people can't, can't partake in like perhaps even thoughtful leverage, they're going to go offshore. And my sense is that if you're a big incumbent derivatives exchange and US persons, you know, can't avail themselves of products and you're keeping them offshore, that bides you some time. And so, yeah, I mean, I agree
- [05:07]
A
with all of that, but my other piece of advice to the CME would be you should be real careful what you wish for on this one. Because as somebody also familiar with the guts of Dodd Frank, one everybody remember the distinction between a future and a swap is at the discretion of the CFTC based on certain factors which are not the payoff profile or strictly having an expiration date. If you really poke the bear, they have a huge amount of discretion looking at these things. They could easily say rolling a futures position is actually a swap because now you have eliminated the expiration date and it needs to trade like a swap, right? And you're not going to like how that works compared to futures treatment. They can also go the other way and say as long as you construct your swap as a rolling sequence of indefinite futures, this is a futures contract. I am also going to point out there are large categories of instruments that are technically within the Dodd Frank definition of a swap that are clearly not swaps and clearly were never intended as such. Good examples are tons of stuff in, in the insurance markets, right, because they have a reference point, a future payoff, an exchange of cash flows, like all of the components that you would think. In fact, if you're a lawyer and you want to be a real grognard, go look at footnote 719D in Dodd Frank and you can find Congress basically admitting we have no idea how the fuck to deal with these things and we're just going to punt on whole categories of products which to this day have not been resolved. So one of the things that's surprising to me here, Chris, and I kind of want your view on, is if you're an incumbent being regulated by a regulator of this sort, and then you are going to pick a fight with your regulator over something where they were clearly delegated authority, don't you risk one of two outcomes, both of which are terrible. One is the agency wins and then is just pissed with you because the delegation of authority was proper. But two is in the current Supreme Court, it goes all the way up and they say one of two things, which is either no, it means what it says and life insurance is a swap and it's been illegal to trade that thing since 2009, so rewind that whole market or life insurance is clearly not a swap, which means Dodd Frank is Unconstitutionally vague. So get rid of all of it.
- [07:38]
B
Yeah. And it gets more complex in the post Chevron era as well, where back in the day if things were vague, the tie would go to the regulator. Now that's been rolled back. So like you really got to go back to the law. It's very complex and time consuming. Right. I think one other perspective to have is what are the other incumbents doing? And ICE has announced a strategic partnership with OkX. OkX is very much involved in the perpetual space. Your ex has announced a strategic relationship with Kraken. And so as these dance partners come together, sometimes you can take a policy issue and at the end of the day it's a business issue. So I think the other thing to watch as this prevent as this case moves forward is where are their competitors and how are they, how are they positioning themselves? It'll be super interesting to watch. But last thing I'll say is that Chairman Sealig, hat tip to him, man. He's, he's fighting the good fight. He's. What I see is I see a leader who's focusing on principles and he's saying, you know, I'm trying to do the right thing for responsible innovation. And he continues to do it every single day in the crypto space. So, Mr. Chairman, just want to say thanks again. We're appreciative because we know what it's like when we don't have someone who's thoughtful about principles based regulation.
- [09:03]
A
Yeah. And I'll, I'll close out before we end the show by saying I also know Mike. Right. One thing that I would suggest here is when you look at the position federal regulators have been put in, they've been handed a mutually contradictory set of principles and rules in many cases. And getting to a point where we can standardize those and have a system that works properly is an important thing, many parts of which have been punted on. And Dodd Frank, you know, another good example is prediction markets writ large in the state versus federal system. I think many of these things in a post Chevron world are going to come down to the courts, but I think it's good that we have a CFTC willing to stake out and explain clear positions and put the flag there and then litigate them to see where things end up. What we ultimately need, pun not intended in this case, is clarity. So I do hope we get there in the end. If you like this segment, please like subscribe and tune in every Monday at 4:30pm Eastern Time. I'm Austin Campbell, the host of Bips and Bips. Along with my friends Rahm Aliwalia and Chris Perkins and our slate of exceptional guests every week we're going to discuss macro, crypto and the collision of worlds, covering topics that move markets and shape the financial landscape.
- [10:24]
C
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