Commodity Trading Entering Mainstream Puts Pressure on Congress
The Bottom Line
- Congress formalizing stablecoin markets is a first step toward addressing the commodity explosion, but lawmakers will have to consider additional steps such as amending the Commodity Exchange Act.
- The evolution of commodities from simple agricultural products to digitized dollars is stretching the capabilities of regulators.
- A flood of non-professional traders has created new opportunities but also requires a new focus on consumer protection.
In the post-pandemic world, several trends are developing that will fundamentally change the way financial market participants manage commercial risk or trade traditional and rapidly evolving novel assets, while new classes of participants are necessitating a fundamental rethink of how federal and state regulators ensure the safety and soundness of US financial markets.
These changes are likely to affect future regulations and compliance needs. For example, exchange trading of novel leveraged commodity contracts on a 24/7/365 basis will require new forms of risk management, such as self-clearing and the use of stablecoins to post collateral. Further, given that most volume will be likely driven by retail participants, new customer protection measures will need to be implemented.
Proliferation of “Commodities”
The legal definition of “commodity” in the Commodity Exchange Act is being stretched far beyond what anyone would have imagined 13 years ago when it was last significantly amended—let alone 100 years ago, when the CEA’s predecessor was first enacted. This categorical expansion has major implications for derivatives markets, as well as on the jurisdictional boundary between the two main market regulators in the US—the Commodity Futures Trading Commission and the Securities and Exchange Commission.
“Commodity” is a term of art defined in the CEA; however, since its inception, the scope of the term has expanded from describing primarily grains to include other agricultural products, energy resources, precious metals, financial instruments, and now digital assets.
As the economy grows and more participants enter the markets, the scope of what constitutes a “commodity” will continue expanding and has recently started to include event outcomes, such as football games, or real estate and art auctions.
However, determining the legal nature of novel products, such as digital assets, can be difficult. Congress should amend the CEA and provide greater clarity on the distinctions between securities, commodities, bank-regulated instruments, and other novel products.
The CFTC and the SEC continue to try to guide the marketplace, such as when the SEC’s Division of Corporate Finance recently opined on whether stablecoins are “securities.”
Significant practical implications are depending on the outcome of “commodity” classification, which include: whether the CEA’s federal preemption applies, whether the SEC’s jurisdiction is triggered, whether state gambling and bucket shop rules apply, how these instruments will be treated in bankruptcy, and to what extent the Uniform Commercial Code will apply.
One thing is certain: There will be much greater diversity in “commodities” in the near future.
“Retailification” of Commodity Markets
Commodity derivatives markets have traditionally been driven by professional participants, such as large farmers and commodity traders, as well as registered and regulated entities.
With the advent of crypto contracts, this has changed. The volumes of derivative transactions are increasingly being driven by retail traders (non-professional participants). This generational shift means the CFTC and the National Futures Association must pivot to focus more on consumer protection issues because regulators can’t rely solely on market intermediaries and financial infrastructure providers to be responsible for protecting retail participants who are increasingly using innovative technology.
Ironically, as retail volume and demand have increased, and more swaps are being cleared, the number of registered futures commission merchants has been significantly dwindling until very recently. However, over the past year, the trend has reversed, and the demand for traditional registered futures commissions merchants and introducing broker services has started to grow.
Even though the proposed digital assets structure legislation will create several specific categories for digital assets, intermediaries, and trading venues, most likely, these new entities will be registered, licensed, and supervised based on the well-established practices concerning already existing registered categories of market participants and financial infrastructure providers.
Accommodating Retail Participants
Given that retail participants can trade margined or leveraged commodities only on exchanges, there is increasing pressure on designated contract markets to broaden their access points for retail participants who are interested in not just digital assets, but also more traditional commodity transactions and are using decentralized finance platforms.
Conversely, unregistered platforms are under increasing pressure to register as designated contract markets to address and accommodate the continuously growing retail demand in commodity contracts that qualify as “futures contracts.”
To accommodate an increasing volume of retail participants, one of the tools under consideration is the creation of fully margined and self-liquidating accounts, where retail market participants can bypass an intermediary, such as a registered futures commissions merchant, and essentially become self-clearing members of clearing houses, i.e., derivatives clearing organizations.
The CFTC will likely eventually bless these structures, such as allowing retail participants placing smaller lot futures trades on an app on their mobile phones at any time of the day. And micro-sized contracts geared toward retail participants are already rapidly gaining in popularity.
Once Congress finalizes legislation on stablecoins and digital assets, the CFTC and SEC will have to issue new regulations to protect retail participants.
Fractionalization and Specialization
Increasing sophistication in risk management demands a greater variety of risk management, speculative, and liquidity tools that can address a wider diversity of derivatives contracts offered on designated contract markets, the smaller sizes of these contracts as well as longer (and shorter) duration compared to “industrial”-size contracts entered into by professional participants on traditional commodities.
The move toward more bespoke and smaller-size contracts, as well as toward zero-day settlement vs. perpetual contracts, is indicative of the greater participation in such transactions by retail participants, which will continue and will pressure the CFTC to further refine its designated contract market self-certification process for futures contracts and options.
Markets are also experiencing an explosion in the variety of assets being digitally tokenized to facilitate blockchain trading. The marketplace now has native tokens that are themselves home equity lines of credit, auto titles, and property titles—all created and traded exclusively on a chain. Tokens now represent money market funds, exchange-traded funds, bonds, precious metals, fine art, and other collectibles. All of these products will require a new level of recognition and legal protection.
If, or more likely when, the CFTC receives the grant of exclusive regulatory jurisdiction (in addition to its already existing enforcement jurisdiction) over spot digital assets, this will be a paradigm shift in market regulation.
Erosion of Tradition
Financial engineers today are developing novel structures to meet customer demands, which include DeFi platforms, decentralized autonomous associations offering commodity contracts traded on the blockchain, and the use of artificial intelligence. As a result, a single entity may simultaneously meet the characteristics of a designated contract market, swap execution facility, derivatives clearing organization, an introducing broker or a futures commission merchant, a swap data repository and a swap dealer, or a security-based swap dealer offering its services seamlessly across the globe.
The 100 year-old regulatory approach implemented by the SEC and the CFTC isn’t flexible enough to regulate these new hybrid structures properly. Regulators and the self-regulatory organizations will have to develop a new regime to regulate and effectively supervise these business arrangements comprehensively.
On May 5, the House of Representatives introduced a discussion draft of a market structure bill to provide direction to regulators on digital assets, marking an important step toward conceptualizing these new structures.
The trend of traditional financial services being disrupted by financial innovation isn’t limited to digital assets and commodities and securities. Throughout the financial sector, the promises of technology are transforming how banks and non-banks alike are offering everything from payments to deposits to personal financial management.
From a regulatory standpoint, this has led to renewed interest among prudential bank regulators, especially the Office of the Comptroller of the Currency, with its chartering authority, to approve special-purpose chartered banks that would only carry out a limited number of banking functions.
Reevaluating “Gaming”
Distinction between “gambling” or “gaming” and trading commodities for a legitimate business purpose (and what a legitimate economic interest is) is at the heart of the CEA and has been argued in courts long before the enactment of the CEA’s predecessor in 1921 or the establishment of the CFTC in 1974.
The industry, the regulators, and courts will continue grappling with these concepts and where the line lies delineating gambling, as is evidenced by recent litigation involving “event contracts,” as well as recent CFTC proposed rulemaking on “event contracts” and an attempt to define what “gambling” is.
“Event contracts” and prediction markets are here to stay, and the definition and common public understanding of what gaming and gambling are in 2025 differs markedly from what was commonly understood just a few years ago. It’s clear the CFTC, and possibly Congress, will have further regulatory action on this class of contracts.
Increased Trading Efficiency
Increased trading efficiency and greater availability of real-time payments are just some of the benefits that could result from a greater use of digital assets in the marketplace.
When commodities are traded as tokens on the blockchain, for example, trading can occur 24/7/365 and don’t need to be restrained by market hours and banking days. This is because blockchain technology achieves final settlement when a token is exchanged from one party to the next, instantly at the speed of the internet, not the traditional banking system.
Similarly, if stablecoins are used to pay for the purchase and redemption of token value, then as soon as a transaction is completed on the blockchain, payment also achieves final settlement.
The CFTC has recently published a request for comment on 24/7 trading of designated contract markets, which is intended to match retail demand for continuous trading sessions.
If one designated contract market or swap execution facility starts 24/7/365 trading, and if at least one derivatives clearing organization accommodates clearing of continuous markets, all other exchanges and trading venues will have to offer the same functionalities. Likewise, futures commission merchants or swap dealers won’t be able to opt out from these markets because they will have exposures created over holidays and weekends and they wouldn’t be able to ignore them.
In tandem, regulations, supervision, and the entire US financial infrastructure will need to adapt to accommodate continuous transaction flow in practically infinite supply of various products.
Enforcement Priorities
The new leadership of the CFTC and the SEC, as well as the Department of Justice, have emphasized that enforcement priorities will be on the protection of retail participants and the public at large from fraud and manipulation, and that there will be no regulation by enforcement.
Furthermore, there will be less need for regulation through enforcement if Congress finalizes its legal framework for stablecoins and digital assets, providing clear guidance on these markets from the CFTC and the SEC.
At the same time, the CFTC’s enforcement lawyers are increasingly reading from the SEC’s rulebook, and insider trading and disclosure cases involving commodities are now commonplace. Inevitably, retail participation will necessitate the CFTC use similar tools as those used by the SEC to protect retail capital markets.
Accordingly, it is expected that enforcement will be of different quality and will target different market actors both on the CFTC and the SEC side.
Conclusion
In the next few years, US (and world) commodity and security derivatives markets will be fundamentally different. It is likely that retail participants will day-trade on their mobile phones numerous futures and options contracts 24/7/365 and that tokenized assets will transfer instantaneously to collateralize these trades.
There will be several new categories of registered market participants (digital asset and digital commodity intermediaries and platforms and AI-driven advisers) in addition to traditional brokers and futures commission merchants who will accommodate this trading flow. Increased risks to institutional and retail market participants will (hopefully) match with greater sophistication of regulators,’ self-regulatory organizations, and DOJ’s enforcement departments.
No asset, commodity, or market utility will remain unaffected by these rapidly emerging trends.
This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law, Bloomberg Tax, and Bloomberg Government, or its owners.
Author Information
Peter Malyshev is a partner in Cadwalader’s financial services group focusing on regulatory, compliance and transactional matters.
Mercedes Tunstall is a partner at Cadwalader focusing her practice on consumer financial services regulation and compliance, fintech, and cryptocurrency.
Daniel Meade is a partner in Cadwalader’s bank regulatory practice.
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