INVESTOR EDUCATION—SEC staff weighs in on CFTC regulated Bitcoin futures markets - 13 May 2021

The SEC’s Division of Investment Management statement urges continued investor vigilance despite increased trading volumes and growing open interest in Bitcoin futures markets overseen by the Commodity Futures Trading Commission.

The SEC’s Division of Investment Management (IM) issued a statement addressing a number of issues funds registered under the Investment Company Act investing in the Bitcoin futures markets should consider. The IM statement strongly encourages investors with an interest in mutual funds seeking exposure to the Bitcoin futures market, to carefully consider the risk disclosure of the fund, the investor’s own risk tolerance, as well as the possibility of loss.

The rise and inherent riskiness of Bitcoin futures markets. The IM report comes at a time when the CFTC-regulated Bitcoin futures markets have seen growing investor interest and participation, as well as increased trading volumes and open-interest positions. Notwithstanding the regulatory protections afforded by the CFTC, the IM statement identifies a number of concerns including the highly speculative nature of Bitcoin futures, their volatility, as well as the lack of regulation and potential for fraud or manipulation in the underlying Bitcoin market. The statement recognizes that IM staff understands the mutual funds which are investing in Bitcoin futures believe they can do so consistent with the substantive requirements of the Investment Company Act, its rules, and other federal securities laws. However, the statement goes on to say that IM staff, in coordination with other Commission staff, will continue to closely monitor and assess ongoing compliance with the Investment Company Act and its rules, noting that the funds’ ongoing compliance is a top priority for the staff.

Revisiting its Cryptocurrency Holdings Letter. In January 2018, IM staff issued its Cryptocurrency Holdings Letter where it identified five substantive areas of concern implicated by funds registered under the Investment Company Act that were engaged in cryptocurrencies or cryptocurrency-related investments. Those areas included valuation, liquidity, custody, arbitrage mechanisms for exchange traded funds ("ETFs"), as well as potential manipulation and other risks associated with cryptocurrency-related markets.

In its statement, the IM recognized the development of the Bitcoin futures markets since the introduction of Bitcoin Futures in 2017, and acknowledged the following:

  • Bitcoin futures markets have consistently produced reportable prices for Bitcoin futures;
  • Bitcoin futures markets have not presented the custody challenges associated with some cryptocurrency-based investing because the futures are cash-settled; and
  • the SEC has adopted a new exemptive rule related to funds’ use of derivatives whose conditions generally include limits on derivatives leverage risk and the adoption and implementation of a derivatives risk management program.

The IM statement also noted that IM staff, in coordination with staff from the Division of Economic and Risk Analysis and the Division of Examinations, will closely monitor the impact of mutual funds’ investments in Bitcoin futures on investor protection, capital formation, and the fairness and efficiency of markets. As part of that monitoring, the staff anticipates the following:

  • Analyzing the liquidity and depth of the Bitcoin futures market and consider whether it is appropriately supporting mutual fund investment in Bitcoin futures;
  • analyzing mutual funds’ ability to liquidate Bitcoin futures positions as necessary to meet daily redemption demands;
  • monitoring funds’ valuations of holdings in the Bitcoin futures market and considering the impact of mutual fund participation in the Bitcoin futures market on valuations in that market;
  • considering mutual funds’ liquidity classification of any position in the Bitcoin futures market and the basis for such classification, and also considering the overall construction of a fund’s liquidity risk management program;
  • assess the ongoing impact of the potential for fraud or manipulation in the underlying Bitcoin markets and its possible influence on the Bitcoin futures market; and
  • considering whether, in light of the experience of mutual funds investing in the Bitcoin futures market, the Bitcoin futures market could accommodate ETFs.

Further public input sought and a commitment to transparency. The Division of Investment Management’s statement also requests further comment from ETFs and other market participants, particularly input that focuses on efforts to ensure compliance with the Investment Company Act and its rules and to promote investor protection. The statement concludes with IM’s commitment to "be transparent about its approach to registered funds’ investment in the Bitcoin futures market", and further observed that such transparency will be designed to avoid market uncertainty and promote a level playing field for funds, consistent with the protection of investors.

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