The Retail Commodity Regime under the CEA and the Role of Actual Delivery
The CFTC has broad authority over the markets for commodity futures (including options on futures), commodity options and, since the enactment of The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank), swaps. The CFTC also has anti-fraud and anti-manipulation authority over commodity spot, cash and forward markets. Beyond these well-known areas of CFTC jurisdiction, the CFTC also has jurisdiction over certain “retail” transactions in foreign currency under Sections 2(c)(2)(B) and 2(c)(2)(C) of the CEA and, also since the enactment of Dodd-Frank, over “retail” commodity transactions under Section 2(c)(2)(D) of the CEA. The CFTC’s jurisdiction over retail commodity transactions is separate and independent from its jurisdiction over the U.S. futures, swaps and spot markets.
The retail commodity provisions of the CEA apply to any “agreement, contract or transaction in any commodity that is . . . entered into with, or offered to (even if not entered into with), a person that is neither an eligible contract participant nor an eligible commercial entity . . . 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” (emphasis added). These provisions are intended to protect unsophisticated “retail” individual investors from fraud. Transactions that are captured by this language are treated as if they were futures contracts, which essentially means that the full CFTC futures regime applies to such transactions. That means retail commodity transactions covered by these provisions must generally be transacted on registered futures exchanges or they are unlawful.
It is important to understand that the retail commodity provisions apply only (a) to transactions with retail investors (i.e., not to institutional transactions) and (b) where there is some element of leverage, margin or financing involved in the transaction. However, the retail commodity provisions also do not apply to a contract of sale that “results in actual delivery within 28 days or such other longer period as the Commission may determine by rule or regulation based upon the typical commercial practice in cash or spot markets for the commodity involved.”
How do the retail commodity transaction provisions apply in practice? Take the example of physical gold. If you sell gold, deliver it to the customer or his or her third-party agent, and collect payment in full, the CEA does not apply. If you sell gold and only collect partial payment, allowing for the purchaser to pay only margin, or otherwise leverage the transaction, but you provide what the CFTC characterizes as “actual delivery” within 28 days, other than the anti-fraud and anti-manipulation prohibitions, the CEA still does not apply. If you sell gold to an institutional buyer, under any conditions short of creating a futures contract, swap or option, other than the anti-fraud and anti-manipulation prohibitions, the CEA does not apply. Only if the sale is on a margined or leveraged basis, or financed by the seller or someone acting in concert with the seller, and “actual delivery” does not occur within 28 days, will the CEA kick in.
The CFTC has previously issued an interpretation of the term “actual delivery” as it is used in this provision (the 2013 Guidance).2 The 2013 Guidance included a list of factors the CFTC believed were relevant in considering whether “actual delivery” of a commodity has occurred, and also provided examples of what may constitute actual delivery. The Commission was most concerned about drawing a distinction between “constructive delivery,” in which a book entry is made with regard to a commodity but no other indicia of delivery occurs, and the statutory concept of “actual” delivery. The 2013 Guidance took a conservative approach to what the Commission was prepared to sanction as satisfactory forms of “actual delivery,” requiring transfer of title and possession of the commodity to the purchaser or a depository indisputably acting on the purchaser’s behalf.
One crucial issue with virtual currency and the CFTC’s proposed interpretation is that since 2013, the CFTC has taken the position that virtual currency is a “commodity” under the CEA. In 2016, the Commission brought its first enforcement action against a platform that offered virtual currency to retail customers on a leveraged, margined or financed basis without proper registration with the CFTC. In that case, the CFTC found that the platform ran afoul of the retail commodity provisions of the CEA because the platform “did not actually deliver bitcoins” (emphasis added). The CFTC instead found that the platform “held the purchased bitcoins in bitcoin deposit wallets that it owned and controlled.” The CFTC did not view this as “actual delivery.”
Following this enforcement case, the CFTC received a request for formal guidance on the meaning of “actual delivery” in the specific context of virtual currency. The requestor suggested that the line drawn in the enforcement action was inappropriate and would unnecessarily limit the development of the market for virtual currency. In recent months, the Commission has been signaling that it was prepared to respond to this request, and it has now done so with issuance of the proposed interpretation.
The CFTC’s proposed interpretation is focused on retail commodity transactions in which an entity or platform offers margin trading or facilitates use of margin, leverage or financing for retail customers. The CFTC said such markets typically enable these retail customers to speculate or capitalize on price movements, which it refers to as “hallmarks of a regulated futures marketplace.”
In the proposed interpretation, the CFTC indicates that in interpreting the term “actual delivery” the CFTC will continue to follow the 2013 Guidance and “employ a functional approach and examine how the agreement, contract or transaction is marketed, managed and performed, instead of relying solely on language used by the parties in the agreement, contract or transaction.” The CFTC in making the “actual delivery” determination will also assess all “relevant factors,” which includes but is not limited to “ownership, possession, title, and physical location of the commodity purchased or sold, both before and after execution of the agreement, contract or transaction, including all related documentation; the nature of the relationship between buyer, seller, and possessor of the commodity purchased or sold; and the manner in which the purchase or sale is recorded and completed.”
More specifically, the CFTC is proposing to require the following in order to find that “actual delivery” has taken place:
- There should be a customer with the ability to take possession and control of the entire quantity of the commodity, whether purchased on margin, or using leverage or financing, and the ability to use it freely in commerce, both within and away from any particular platform, not later than 28 days from the date of the transaction; and
- The offeror and counterparty seller, including any of their respective affiliates or others acting in concert with them on a similar basis, not retaining any interest in or control over any of the commodity purchased on margin, leverage or financing at the expiration of 28 days from the date of the transaction.
The CFTC goes on to state that “actual delivery of virtual currency connotes the ability of a purchaser to utilize the virtual currency purchased ‘on the spot’ to immediately purchase goods or services with the currency elsewhere.” Further, the CFTC states that “physical settlement of the commodity must occur.”3 Two-thirds of the way through the proposal, the CFTC makes a comparison between virtual and fiat currency, stating that “[t]he distinction between physical settlement and cash settlement in this context [i.e., settlement of virtual currency] is akin to settlement of a spot foreign currency transaction at a commercial bank or hotel in a foreign nation – the customer receives physical foreign currency, not U.S. dollars.” Of course, this distinction ignores the fact that, in this day and age, even many fiat currency transactions do not involve the receipt or the payment of physical currency.
The CFTC goes on to provide a number of examples and counter-examples where it believes actual delivery should or should not be deemed to have taken place. These examples provide useful signposts of how the CFTC views virtual currency, and we imagine that the examples will be fertile territory for those interested in commenting on the proposal. As with virtually all regulatory responses to virtual currency, the CFTC is faced with the challenge of adapting a legacy regulatory structure (in the case of the CFTC, dating to a time when even automobiles were considered a novel technology) to an entirely new type of transaction. This is evidenced by the examples the CFTC provides in the proposal, the focus of which lean somewhat on comparisons to assets that have a physical form and that are capable of being “delivered” in a literal sense.
This CFTC proposal presents a unique opportunity to engage with the CFTC and help the CFTC build a regulatory record around virtual currency on which the CFTC may act in the future. The CFTC has demonstrated a desire to understand the market for virtual currency and to allow the market to evolve somewhat organically, but the CFTC has also expressed the same sorts of concerns as the Securities and Exchange Commission and other regulators about the need for protecting investors against the risks of a very volatile asset class to which the CFTC believes many sharp operators and bucket shop brokers will be attracted to and for which vulnerable unsophisticated investors will be targeted.
We look forward to discussing the CFTC’s proposal with our clients and engaging with the CFTC staff on these issues on our clients’ behalf.
1 Commodity Futures Trading Commission, Retail Commodity Transactions Involving Virtual Currency, 82 Fed. Reg. 60335 (December 20, 2017); available at www.gpo.gov/fdsys/pkg/FR-2017-12-20/pdf/2017-27421.pdf.
2 See Retail Commodity Transactions under the Commodity Exchange Act, 78 Fed. Reg. 52426 (August 23, 2013).
3 These “immediacy” and “physical settlement” requirements may present opportunities to comment, given that certain virtual currency networks are experiencing transaction cues that significantly delay the delivery of the underlying virtual currency. In some cases it is currently taking days or even weeks for transactions to move from “pending” status to settled.
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