CFTC Approves LedgerX Bitcoin CCP

Long-awaited ruling shows digital currencies are pushing for institutional-grade market structure

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New York-based LedgerX is the first CFTC-regulated SEF and DCO to offer bitcoin swaps.

The top US derivatives regulator has granted approval for a bitcoin clearinghouse—the first entity of its kind and a major step forward in bringing institutional-grade infrastructure to the volatile digital currencies asset class.

The US Commodity Futures Trading Commission (CFTC) gave its long-awaited approval to LedgerX’s derivatives clearing organization (DCO) application on July 24, which will permit the firm to clear swaps on bitcoin.

“A U.S. federally-regulated venue for derivative contracts settling in digital currencies opens the market to a much larger customer base,” said Paul Chou, CEO of LedgerX, in a statement. “We are seeing strong demand from institutions that previously could not participate in the bitcoin market due to compliance restrictions against unregulated venues. In particular, there is a desire for fund managers to hold financial instruments that are not correlated with the broader equity market, and digital currencies meet that need.”

LedgerX will initially offer options on bitcoin, but plans to extend its product offerings to other instruments, and further digital currencies, in the future, according to people familiar with the situation. The CFTC has also granted LedgerX an exemption from Section 39 of the Commodity Exchange Act, which would have required the clearinghouse to undertake monthly stress tests of its financial resources to ensure that it could withstand the default of its largest participant.

As LedgerX’s options model is fully collateralized, the CFTC accepted that this requirement did not necessarily apply as it would to clearinghouses that use initial and variation margin models, and granted an exemption.

The approval follows an order from the CFTC on July 6, 2017 granting full registration to its swap execution facility (SEF). LedgerX’s DCO will clear solely for the SEF at present.

The applications for both the SEF and the DCO registration have been in holding for some time, with LedgerX initially filing its application in 2014. The CFTC extended the initial comment period on the application, in part due to the nature of the digital currency market, which has struggled to gain official sanction from other regulators regarding different products.

The US Securities and Exchange Commission, for instance, rejected a rule amendment filed by Bats Global Markets in March 2017, which would have allowed the exchange operator to list an exchange-traded fund that tracks bitcoin. The SEC is reviewing its decision following an appeal by Bats in April 2017. Bats declined to comment on the progress of that review.

LedgerX’s approval is the latest attempt to create an institutional-grade infrastructure around the digital currency market—another SEF, TeraExchange, also offers forwards on digital currencies—and particularly important in terms of encouraging institutional interest in the nascent asset class, which has so far been limited due in large part to perceived flaws in its market structure.

Digital currencies do not include elements of market structure found in more mature asset classes, for instance, such as a functioning derivatives market for hedging purposes, segregated custody or intermediary roles, prime brokerage functions or other such areas.

However, efforts are underway to offer products in this regard. XBT Provider, owned by Jersey-based asset manager Global Advisors, lists two exchange-traded products that track bitcoin on Nasdaq Nordic, while a number of bitcoin-specific hedge funds have been created in recent years.

Despite this, efforts are at an early stage. The SEC, in rejecting the Bats rule amendment, cited the lack of maturity in market structure and its potential vulnerability to market manipulation in its reasoning.

An in-depth feature on institutional engagement with digital currencies—and the hurdles that have yet to be overcome before they can be considered an investable asset class—will be published in the August issue of Waters magazine.

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