By Clifford C. Histed and Cheryl L. Isaac

Last week, after years of silence on the issue of digital asset regulation, the National Futures Association (“NFA”) promulgated new anti-fraud, just and equitable principles of trade, and supervision requirements on NFA Members  that engage in “digital asset commodity activities.” Compliance Rule 2-51  puts NFA Members on notice that the NFA will assert enforcement authority over any fraudulent, manipulative, or deceitful activity related to Bitcoin and Ether spot transactions, and requires that NFA Members “diligently supervise” their employees and agents in the conduct of these activities.

The NFA is a self-regulatory organization for the U.S. derivatives markets, with jurisdiction over certain Commodity Futures Trading Commission (“CFTC”) registrants, including futures commission merchants (“FCMs”), introducing brokers (“IBs”), swap dealers (“SDs”), commodity pool operators (“CPOs”) and commodity trading advisors (“CTAs”).  The NFA is itself regulated by the CFTC.  Typically, the NFA regulates its members’ derivatives activities, and this new Compliance Rule is noteworthy in that it addresses spot market activity.

Beginning on May 31, 2023, any NFA Member (including each of the entities listed in the paragraph above) that engages in activities related to spot Bitcoin and Ether will be subject to potential disciplinary action by the NFA for bad acts by its employees and agents.  NFA Members should assume that NFA expects them to implement related policy and procedures, and provide regular compliance trainings to employees.

Also notable, Compliance Rule 2-51 only addresses Bitcoin and Ether.  While the CFTC has asserted jurisdiction over  a much broader range of digital assets (including a number of stablecoins), the NFA is taking a more conservative approach and only applying its new rule to its members’ activities in  digital assets that are underlying listed exchange-traded derivatives (e.g., Bitcoin and Ether futures contracts on CME).  The NFA left open the possibility that it would broaden the scope of its rule to other types of digital asset commodities in the future.

Previously, the NFA had issued Interpretive Notice 9073 (effective as of October 31, 2018), requiring FCMs, IBs, CPOs and CTAs to provide certain risk disclosures to customers related to virtual currency derivatives and virtual currency transactions.  Among other things, those disclosures were intended to warn market participants that the NFA does not have regulatory authority over the spot market for digital assets.  New Compliance Rule 2-51 includes a reminder that NFA Members continue to be subject to these disclosure requirements.

On Friday, Commissioner Caroline Pham issued a statement in support of the NFA’s new rule.

Questions?  Please contact Clifford C. Histed, Cheryl L. Isaac or any member of the K&L Gates Derivatives Working Group or Digital Assets, Blockchain Technology and Cryptocurrencies Industry Group.