Caroline Pham was sworn in to her post as Commisioner of the Commodity Futures Trading Commission (CFTC) in April 2022. She’s recognized as a leader in financial services compliance and regulatory strategy and policy, with deep expertise in derivatives, capital markets and digital innovation. Commissioner Pham previously worked at the CFTC as a Counsel and Policy Advisor under Scott O’Malia and worked at Citi in a number of market regulatory and strategic market roles.
In this conversation we discuss the status of crypto regulation, the Lummis-Gillibrand bill, the historical context behind the CFTC’s and SEC’s jurisdictional divide and investor protections for crypto assets.
Watch the full interview live on YouTube.
Forbes: Thank you for joining us today. A lot is going on in crypto and in the regulatory world. What is it like being a regulator in crypto right now?
Caroline Pham: Before I begin, I want to give my standard disclaimer, which is that the views that I’m sharing today are my own and do not reflect the views of the CFTC or any other commissioner. I have to say, being a regulator in crypto right now is so exciting. That is the reason why I gave up my former career to heed the call to public service, come back to the public sector and work on it. Right now is just such an inflection point where you have a trillion dollars in crypto assets that are out there, you have such widespread investigation and adoption of this technology. It’s so important that we get the guardrails in place and that we build out the regulatory framework from the beginning. So that way the growth that we’re seeing is in compliant digital asset markets and not in something that is outside the banking system or outside the regular financial system, which I’ve been calling “shadow banking 3.0.” It’s really an opportunity to come in to try to use my experience and my expertise, both previously when I was at the CFTC after Dodd Frank but then also from the private sector, to get that balance right between innovation and between retail protections.
Forbes: The market cap has dropped below $2 trillion over the last six months or so, yet the industry keeps innovating. I know for instance, last month you participated in a roundtable with Sam Bankman-Fried related to innovative proposals to a novel way of clearing derivatives. How are you weighing all these competing pressures?
Pham: Absolutely. First, one of the points that I’ve made recently in my public statements is that shifts in market structure are not necessarily new, either to the CFTC or to regulators generally. One of the parallels I drew was the electronification of markets and how we are seeing that with essentially the digitalization [of markets] into digital assets, where you can have assets that are essentially a tokenization of real assets. You take a real asset, make a representative token and then you put it on a blockchain. So with these efficiencies that you can see in the technology, a lot of times you can use the existing regulatory framework or you might need to update it to look at some guidance or some interpretations where you apply it to the new technology that is truly novel. But for the most part, the CFTC’s principles-based framework is technology neutral, which I do think is better. It means that the rules can be more evergreen; it means that they don’t need to be updated all the time. That’s just one example where I really see the ongoing digitalization and the growth in digital asset markets is almost very, very similar to the electronification of trading markets, where you’ve had equities, effects, fixed income, rates and so on. I think that’s a really good parallel. I can’t speak specifically about any applications that are pending before the CFTC right now, [but] I do think that it’s very important to have that robust public debate and discussion. So I’m very pleased that we were able to have such a fulsome roundtable, with participants from all different sectors and aspects of the markets from your financial market infrastructures, like exchanges and clearing houses, all the way to end users, like the farmers and ranchers that the CFTC markets were originally built for.
Forbes: Another example, aside from the digitization of markets, of how the CFTC approaches novel technologies and changes in market infrastructure is swaps. In past interviews you’ve mentioned how certain derivative contracts in crypto perhaps could be considered swaps. Can you expand on that?
Pham: When you look at the different crypto assets that are out there that are used for trading purposes, you have these sorts of novel and digitally native crypto assets like bitcoin, so those are digital commodities. But when you look at some of these other tokens, especially ones that aren’t, for example, a tokenized security or some other financial instrument or sometimes you can see tokens that are essentially existing financial instruments but they’ve been rebranded to be called something else but look very similar to some kind of swap.
The definition of a swap is very broad, so it is important to look at what we have that already exists. In particular, because many of these tokens could be structured as derivatives or they are structured as derivatives, we already have a comprehensive regulatory framework for that, which Congress put into place with the Dodd Frank Act, where it does have the jurisdiction delineated between the CFTC and the SEC – that’s how we’ve brought the $700 trillion notional swaps markets under comprehensive regulation, from prudential requirements, like capital and margin, to business conduct requirements, risk management requirements, compliance program requirements and protections for not only market integrity, but also for users of the markets, including end users and customers. I think that’s a really sensible way to look at it for when you’re doing that technical legal analysis over what type of financial instrument or product that particular token is. First to identify what it is, then you know what rules go along with it.
Forbes: Let’s talk a little bit about regulation moving forward. There are plenty of other countries that have one financial regulator and everything fits under it, but in the U.S., we have sister agencies – the CFTC, the SEC, the CFPB, state regulators, etc. When I’ve interviewed SEC Commissioner [Hester] Pierce and former SEC Chairman Jay Clayton, they talked about the healthy relationship they have with the CFTC both in and outside of crypto. What is your perspective?
Pham: This is something I think has been recognized since the very early days of the Commodity Futures Trading Commission. Its predecessor agencies had been around since the beginning of the century. But the current structure of the Commodity Futures Trading Commission was put into law by Congress in 1974 and then I believe our first chairman was sworn in in 1975. So in the early 1980s, they realized that they needed to work out some of the jurisdictional lines between the SEC and the CFTC, so you have the Shad-Johnson Accord that was put into place. That was then-SEC Chairman Shad and then-CFTC chairman Phillip McBride Johnson, who was my professor in law school, so he actually taught me regulation of derivatives. That was, I think, the first time to really just draw a line because they realized the two agencies needed to work together, that we had some different financial products that had some [different] characteristics. One very good example of that is security futures. I won’t bore you with all the details of how that got hashed out but it did take quite a bit of time, [but] it was one example where they needed to look at the different characteristics of products [that] might be the appropriate regulatory framework around that.
Forbes: What are your thoughts on the Gillibrand Lummis bill?
Pham: I think this bill is a comprehensive attempt at laying out a really holistic regulatory framework, as I mentioned previously, over all different types of digital assets in the United States, with U.S. firms and with U.S. investors and consumers and there is, more broadly speaking, the retail public. I think it touches upon a lot of different issues that people have been struggling with over the years as far as trying to get regulatory clarity. All the way from tax issues, to what do you do with a token that is an ancillary asset that is not a securities offering from the first instance but how to provide disclosures around that to the SEC, while having it be regulated by the CFTC. I think that’s a really thoughtful attempt to try to provide a runway for some of these different initiatives or projects that are getting started, at least in the early stages, when that’s how they’re being organized. Then they touch upon stablecoins. There’s a lot of other different aspects of the bill as well, like requiring a study for a self-regulatory organization over digital assets, having an advisory committee that’s comprised of both regulators and the public. I look forward to learning more about what the feedback is on this bill and to see what the legislative process is as it continues to develop and go forward.
Forbes: I think there is some hope that because it is a bipartisan bill, it has a better chance of passing than the Token Taxonomy Act and some other predecessors that fell short. What is most important to you in this bill as a CFTC Commissioner?
Pham: One of my first principles, and really almost a guiding North Star for me, is that when we are regulating and when people are trying to navigate regulated markets, it’s so important that there are clear rules of the road. It stems from that – you need to know what a product is and you need to know what the rules are that apply. If people are going to be putting in their hard capital investments, they’re going to be dedicating their time and energy, harnessing American innovation, then it’s incumbent upon us as regulators to make sure that there’s a clear regulatory framework with clear rules of the road so that people can have the growth in compliant digital asset markets. I have found in all my various discussions, during my learning tours and my demos, which I’ve had both in the private sector and in the public sector in my current role, of some of these really innovative token projects, that people want to comply with. I think that the responsible actors in the crypto asset sector want to comply. They are just wringing their hands saying, well, but what do we do? Nobody will tell us what we do. They’re spending millions of dollars on attorneys, on consultants and on lobbyists trying to figure out how [to] navigate this. There is a very serious concern that I found about national security and about American competitiveness. I think that’s very compelling. I found it to be very sincere and I think that’s something we can’t forget either.
Forbes: I’ve heard it’s a national imperative, it’s important for our economic standing to remain at the forefront of innovation, but how does that fit into national security for you?
Pham: When you look at traditional schools of thought around geopolitical power, you have of course military power and you have economic power. You have the U.S. dollar as the world’s reserve currency. I think people are very concerned that [if], because of these innovations and digital assets in particular—there really is a movement towards certain stablecoins, for example, payment stablecoins that are not clearly digital fiat because that would be a CBDC, and they’re also not tokenized commercial bank money—if there’s ambiguity over regulation over what those stablecoins might be, people are really worried that there’s going to be a movement away from the U.S. dollar as the world’s reserve currency. That is a national security issue for the United States as well as a monetary policy issue. That’s just one example. But of course, if you have innovation, capital investment [and] talent, all moving offshore, that’s something that people see as a concern as well. You’ve seen that with other sectors that have moved offshore that can put the U.S. at a competitive disadvantage – it can be detrimental to our standing in the world. From Covid you’ve seen some issues when we’ve got a lack of onshoring facilities. So these [are] really, things that people are thinking about and are concerned about. I think there are also concerns about what it means again, from a geopolitical perspective, should another currency arise as the world’s reserve currency. Or if there’s a non-state currency, so to speak, that becomes a world’s reserve. That’s another thing I think people are very concerned about.
Forbes: One concern I’ve heard a few times about the bill, because the popular reading of it suggests that the CFTC will gain a lot more authority vis-à-vis the SEC when it comes to regulating the market should it pass in its current form, is that the CFTC does not have the same type of manpower as the SEC to effectively monitor this marketplace. How do you respond to that?
Pham: This is something interesting that people have put out there. If you look at just budget dollars and just headcount, the SEC has a bigger budget and the SEC has more headcount than the CFTC. But I think that also has a lot to do with the fact that the SEC regulates public capital markets and they regulate the private capital markets. Their rules are very prescriptive. It’s very important that not only are there a lot of filings and applications that have to be reviewed, but there’s also many, many enforcement actions over prescriptive rules, which means there are more violations of those rules, because they are so stringent. But with the CFTC, we have a principles-based regulatory framework and we have what our statute mandates as an effective system of self-regulation. So what we have at the CFTC is really harnessing the leverage of all these different market participants and these market infrastructures and making sure that they are also in charge of enforcing our rules. It’s not just the CFTC that needs to enforce these rules, but it’s also every single registered entity that has its own rulebook and has to enforce those rules as well. That’s a really important way that the CFTC is able to make sure that from the top all the way down, we have effective enforcement.
The CFTC has brought more than 50 enforcement actions in the crypto space since about 2015, when we first came out with our action that said that bitcoin was a commodity. It’s really important that people understand that the CFTC regulates not only the most complex products in the world, and that the definition of a commodity is so broad that you’re talking about hard commodities, like precious metals, gold and silver, along with energy products like oil and natural gas. It also includes food commodities, lumber, financial instruments, like interest rate swaps, and Treasury futures, and pretty much weather derivatives as well. There are [also] event contracts that are under the CFTC’s jurisdiction. So this is an incredibly broad swath of markets that’s under CFC jurisdiction, which have worked well for decades in our regulatory framework through incredibly volatile times of market disruption and market stresses. That’s something that people don’t really understand—how broad the CFTC’s jurisdiction is, especially because we have global jurisdiction. I don’t know any other regulator over the commodity derivatives markets with that kind of global jurisdiction.
As a final point, I’ll note that the CFTC regulates systemically important financial market infrastructures (FMIs) both U.S. and non-U.S., like exchanges and clearing houses, but also systemically important global financial institutions, banks, both U.S. and non-U.S. that are directly registered with us as swap dealers. That level of direct oversight over both FMIs as well as banks, U.S. and non-U.S., is incredibly broad. So I [don’t] think you have any regulator, besides maybe the Fed, but I would say that the CFTC actually directly regulates these FMIs to an extent that the Fed does not.
Forbes: To illustrate that for readers—a regulated exchange under your jurisdiction, like the CME, can choose to offer certain products and it’s incumbent upon them to do the first regulatory check. The CFTC obviously, can come in if it feels that it’s not an appropriate product, or it’s not a commodity, for instance. But it’s the regulated exchanges that self-authorize certain products. Is that how it works?
Pham: We have this regime of self-certification. We require that when any exchange wants to list a new contract for trading it needs to certify that it meets all these different core principles and other specific requirements that we have, including that it’s not susceptible to manipulation and other protections. Then it does go to the CFTC for review, [which is] where the CFTC can step in and say that this requires further review and approval by the CFTC before it can be listed. It is something that has been in place because of the need for new risk management products as truly users of the markets—like commercial end users or agricultural end users or corporate entities that are trying to hedge their different risks to dealers that need to manage their risk—as these new risk management products are developed, the CFTC statute requires that we promote responsible innovation and fair competition. So the method of self-certification, that framework around it, really facilitates that statutory purpose of mandate.
Forbes: You look at underlying markets and their vulnerability to manipulation. Bitcoin contracts have been offered by CME for quite some time; the SEC has so far refused to approve any spot ETF save for futures-based ETFs and inverse ETFs. How does the underlying spot bitcoin market impact the performance of futures contracts? In a more general sense, obviously, the unregulated derivatives market and crypto are far bigger than the spot market and far bigger than the regulated derivatives market. How does all that fit into your calculus?
Pham: It’s very important that whenever you have a type of financial product that has a reference asset, you really need to look at how that financial product is deriving its pricing, the model around its pricing and other risk management around the development of the model and [deployment of] that model. So the first thing for many of these products is: How are they structured? How are they built? What are the different ways that it deals with market risk in the specifications for that product? That’s really where you start. But it’s so important that again, when you look at how pricing is developed, when you look at what they use as benchmarks for that reference asset, the way that those benchmarks are put together, they need to be free from manipulation and not be readily susceptible to manipulation per our core principles.
Looking at, for example, LIBOR, and all the work that’s been done globally around strengthening benchmark reform is a really clear example of what can happen if you don’t have robust methods around developing benchmarks. You then have products that use those reference assets for pricing purposes, so it’s really something that’s a much bigger issue that needs to be viewed in context and holistically. That’s another reason why it’s so important that we put regulation around the spot crypto markets because you do have other financial products that are keyed off the prices and the benchmarks that are being developed around crypto products, and we need to make sure that those are robust. That has been a concern that the SEC has pointed to as for why it’s not yet approved a spot bitcoin ETF. We’ve seen that with our listed bitcoin futures markets that they have performed well, and especially because of the way that they are put together, we feel comfortable with those products. But it’s always something where the deeper and more liquid the asset class, then I think you’re going to find more reliability as well and better price discovery.
Forbes: One of the big recent investing trends is retail participation in derivatives markets, options in particular, both in crypto and in traditional equities. When do you think it might be appropriate, or what is an appropriate level of involvement, for retail traders to get involved in derivatives? In particular, margin, borrowing funds to invest, is something that can become particularly troublesome, especially for novice investors that don’t quite understand what they’re doing. How does the CFTC work to make sure that retail investors, to the extent they are able to participate in these markets, do so as responsibly as possible?
Pham: This is such an important question, I’m so glad you are asking it. One of the things that I’ve been saying when we’ve tried to come up with a pragmatic approach to regulation of digital assets is that as we are looking forward, we have to also not forget to look back. These are issues that have been dealt with before and where there are lessons learned that we can take to heart and see what worked in the past and how things work since then, and how that will apply to perhaps this product and this asset class, and what really should we be taking forward from that. So for example, with retail foreign exchange products, that’s an area where there was a lot of not only interest from retail participants, but there were also a lot of scams and fraud. It was awful how you always seem to have the scammers and the fraudsters moving in first into new and innovative areas, particularly ones that have a lot of press coverage and a lot of hype or whatever you want to call it. When you had that happening with the retail forex markets, that’s where Congress stepped in and said, you know, what, the CFTC, which was experienced in this asset class, which was experienced with dealing with these products and with the different types of derivatives on forex, should have a comprehensive framework around it. So there’s a registration framework, there are financial resource requirements, there are market conduct requirements and market integrity requirements. And there’s reporting to regulatory requirements, compliance requirements, risk management requirements, the whole nine yards. I think looking at the retail forex example of how that regulatory framework was built around that space and whether it worked or how it could be improved. It is working. But if there’s anything that could be improved, or something to make it maybe more fit for the purpose of crypto assets, I think that’s one.
But then there’s another one; we have, again, a whole regulatory framework around spot, retail leveraged commodity transactions, so where people are trading on margin, or where there is financing. And again, that’s another place where the Congress has given the CFTC that authority in our statute, and we’ve built up a whole regulatory framework around it. This has been around for a couple decades. So again, this is a really important place that as we are seeing what’s happening right now that we have to not forget to look at the lessons learned that we have in the past and see what works, and if it works here, too.
Forbes: Is there anything that I did not ask that you’d like to share or mention?
Pham: Thank you. Yes, one of the things I keep saying that is so important is that regulators and the public sector really need to engage with the private sector. They need to engage with people who are running the businesses, who are putting their money where their mouth is, who are investing in these areas and building up firms and creating that innovation that is so characteristic of America and American markets. Through my global markets advisory committee—which are these federal advisory committees that different federal agencies can utilize to have a structured and formal way to engage with the public and to get public input into policy making issues of great import to the U.S.—I want to make sure that we are really looking at ensuring that there’s a level playing field for global businesses and global markets around the world. In making sure that as we’re building out responsible regulatory frameworks, we are promoting international engagement and global cooperation and coordination, because these are global markets. It’s so important that you don’t have this instance, where there’s a race to the bottom, or there’s regulatory gaps between jurisdictions, or we have unintended consequences like market fragmentation or regulatory arbitrage. I’m really looking forward to using my global markets advisory committee to further explore these issues with the experts from the industry who are doing this every single day, including some of the different areas that we could look at, for example, our global market structure or also digital asset markets.
Forbes: Thank you.
Maria Gracia Santillana Linares contributed to this article.