Episode 22: NFA Rulebook - Interpretive Notice 9073 (Part 2)

Episode 22 features Core Compliance’s very own Compliance Consultant Adam Stutz, who rejoins us this week to jump right back in to share his insight directly from the National Futures Association ("NFA") Rule book.

 

 

CCO Buzz: Hello and welcome back! We hope you’re all eager to continue our conversation on the NFA’s Interpretive Notice 9073, as well as the Virtual Currency Disclosure Requirements for Pools and Managed Accounts. Episode 22 features Core Compliance’s very own Adam Stutz, who rejoins us this week to jump right back in to share his insight directly from the NFA Rule book.

Adam, I believe last week’s episode we discussed the unique features of virtual currency, price volatility, valuation and liquidity, cybersecurity and the opaque spot market.

Listeners, if you missed out on last week’s episode we recommend circling back to episode 21 to get our full discussion.

But I think right before we “paused” from last week’s episode we were about to talk about virtual currency exchanges, intermediaries, and custodians. Adam, take it away.

Adam Stutz: Virtual Currency Exchanges, Intermediaries and Custodians, as well as other intermediaries that are used to facilitate virtual currency transactions are largely new and unregulated in both the United States and many foreign jurisdictions. Virtual currency exchanges generally purchase virtual currencies for their own account on a public ledger and allocate positions through internal bookkeeping entries while maintaining exclusive control of the keys.

Under this structure, virtual exchanges can collect large amounts of customer funds. Thus, for the purpose of buying and holding virtual currencies on behalf of their customers. But the underlying spot market and the lack of regulatory oversight creates a huge risk because it may not hold sufficient virtual currencies and funds to satisfy its obligations and that such deficiency may not be easily identified or discovered.

Additionally, many virtual currency exchanges can experience significant outages, downtimes, and transaction processing delays and may have a higher level of operational risk than regulated futures or securities exchanges. If virtual currencies are traded or held through an exchange, intermediary or custodian, then the risks associated with engaging in these transactions should be explained.

Regulatory Landscape is another important disclosure. Virtual currencies face an uncertain regulatory landscape in the United States and many foreign jurisdictions. In the United States, virtual currencies are not subject to federal regulatory oversight but may be regulated by one or more state regulatory bodies.

Additionally, many virtual currency derivatives are regulated by the CFTC, and the SEC has cautioned that many initial coin offerings (“ICOs”) are likely to fall within the definition of a security and are subject to U.S. securities laws.

One or more jurisdictions may, in the future, adopt laws, regulations or directives that affect virtual currency networks and their users. But risks associated with the current regulatory landscape for virtual currencies should be explained.

Technology is also a key disclosure. This is a relatively new and rapidly evolving space for technology. And the technology underlying virtual currencies introduces unique risks. A private key is required to access or transfer a virtual currency on a blockchain to a distributed ledger. For example, a unique private key is required to access, use or transfer a virtual currency on a blockchain or distributed ledger. Loss, theft or destruction of a private key may result in an irreversible loss.

The ability to participate in forks could also have implications for investors. For example, a market participant holding a virtual currency position through a virtual currency exchange could be adversely impacted if the exchange does not allow its customers to participate in a fork that creates a new product. The risks posed by this nascent technology should be explained.

Disclosures with respect to transaction fees are also really important. Virtual currencies allow market participants to offer miners (i.e., parties that process transactions and record them on a blockchain or distributed ledger) a fee.

This is not mandatory, a fee is generally necessary to ensure that a transaction is promptly recorded on a blockchain or distributed ledger. The amounts of these fees are subject to market forces and it is possible that the fees could increase substantially. Virtual currency exchanges, wallet providers and other custodians may charge high fees that are relative to custodians in many other financial markets. The impact of these transaction fees on performance should be explained.

CCO Buzz: That explains quite a bit. Now, the virtual currency derivatives disclosure requirements for pools and managed account programs- I don’t get it, could you explain?

Adam Stutz: While NFA doesn’t intend to prescribe standardized disclosure language for CPO and CTA Members. Those members engaging in virtual currency derivative transactions in a pool, exempt pool or managed account program, have a number of unique features that CPO and CTA Members that engage in these transactions must address in their disclosure documents, offering documents and any promotional material related to the Member's activity in virtual currency derivatives.

Bottom line, make sure that you’re familiar with the NFA’s requirements for disclosures related to virtual currencies in pools and managed accounts. If you have any questions or concerns about the disclosure requirements related to virtual currency or need assistance in crafting those disclosures please contact us at (619) 278-0020.

CCO Buzz: Well that’s it for this week’s episode. If you’d like additional information, please check out our website at www.corecls.com. You can also follow us on Facebook, LinkedIn or Twitter @CoreCLS. Thank you and we hope you tune into next week’s episode of the CCO Buzz.

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