1. Introduction

Good morning. It is my pleasure to join you today for the South African Reserve Bank’s Fintech Summit. I would like to thank everyone who worked tirelessly to organize the event. I am particularly thankful for the efforts of Lyle Horsley, Divisional Head- FinTech of the South African Reserve Bank. The remarks that I will share reflect my opinion and not the views of the Commission.

I would like to focus my remarks on a set of twin issues emerging in financial markets and the relevant implications. My remarks intimate that there are a number of novel financial products and new and emerging technologies, but certain products, market structures and technologies merit careful consideration.

First, the Summit rightly focuses on the development of crypto assets as an issue on the global financial markets landscape. In my remarks, I’ll explore the U.S. regulatory landscape. In addition, I will explore the Commodity Futures Trading Commission’s (CFTC or Commission) crypto-enforcement agenda.

Second, I agree that artificial intelligence, a technology long integrated in financial markets for predictive pricing, risk mitigation, and enforcement surveillance and in other pattern-detection contexts has evolved. As the agenda for today’s program reflects, the transition beyond reinforcement learning to generative artificial intelligence represents a marked shift. Employing generative AI models in contexts beyond natural language processing may present challenges for existing regulation. These challenges may amplify risks in both traditional financial markets and decentralized markets.

Finally, the development of crypto assets in certain sectors of the economy may create unique concerns regarding market integrity and, without sufficient guardrails, may impede the successful development of the market. Specifically, for the U.S. CFTC, I am thoughtful about the development of tokenized environmental commodities, namely the tokenization of voluntary carbon credits (VCCs). Let’s tackle each of these in turn.

I am hopeful that my presentation and the presentations over the course of today will lead to generative conversations, effective enforcement of existing authority, and the thoughtful development of innovative regulatory policy that addresses emerging financial products and technologies.

2. Regulating Novel Financial Products and Market Structures

It is an honor to work with the incredibly talented staff of the CFTC and my fellow Commissioners. April 15^th marks the 50th anniversary of the Commission.

The 50^th Anniversary of the CFTC

The Commission was established pursuant to the Commodity Futures Trading Commission Act of 1974, which Congress passed and President Gerald Ford signed into law in October 1974. Congress established the CFTC as an independent federal agency. On April 15, 1975, four of the first five CFTC members, including the CFTC’s first Chairman, were sworn in.

The CFTC initially conducted its business in the cafeteria of the Department of Agriculture. The agency now has more than 700 employees at its headquarters in Washington, D.C. and three regional offices in New York, Kansas City, and Chicago. The Commission, and its dedicated employees, endeavor to carry out the mission of the Commodity Exchange Act (CEA)—the Commission’s enabling statute.

In the 1980s, market participants developed a novel over-the-counter (OTC) swaps derivatives or swaps market featuring instruments that shared characteristics with existing futures contracts and had similar economic purposes. Notwithstanding the rapid, exponential growth in the swaps market, Congress exempted certain OTC derivatives from the scope of the CEA, subject to certain conditions.

As a result of the deregulation of the swap markets, for a time, the CFTC had limited visibility in the OTC swaps market. Disruption in the OTC swaps market served as a precipitating catalyst to the onset of the global financial crisis that began in 2007. According to the U.S. Government Accountability Office, the 2007-2009 financial crisis, which threatened the stability of the U.S. financial system and the health of the U.S. economy, may have led to $10 trillion in losses, including large declines in employment and household wealth, reduced tax revenues from lower economic activity, and lost output (value of goods and services).[1]

As a response to the global financial crisis, Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), which was signed into law by President Barack Obama on July 21, 2010. The Dodd-Frank Act enacted legislation introducing mandatory clearing obligations and much needed market infrastructure reform to address opacity in the OTC swaps market.

For each asset class that the CFTC regulates, the Commission should offer a regulatory framework that emphasizes transparency, protection for our most vulnerable customers and enhances the integrity and stability of the U.S. and global financial markets.

It is important to understand the scope and contours of the Commission’s authority. “As derivatives markets have evolved, so too has the mission outlined in the [CEA], the mandate of the [CFTC]. Our broad anti-fraud and market manipulation authority stretches across an expanding and evolving universe of derivatives markets.”[2]

3. Crypto Assets

There is no single, widely-adopted legal definition of a term “digital asset.”[3] This poses a challenge for domestic and international regulators. The attributes that characterize these assets may be varied and complex. Digital assets are built on complex underlying technological infrastructure- distributed ledger technology (DLT).

During my service as a Commissioner, I have noted several key vulnerabilities in the crypto market ecosystem including the lack of effective anti-money laundering protocols; risk of market manipulation including insider trading and fraud; lack of transparency, accountability and governance; a pathway for illicit transactions and activity; cybersecurity threats (particularly in the context of defi cross-chain bridges); single points of failure; market structure risk; macroprudential economic risk; and energy resource consumption.[4]

There is a significant need for careful development of comprehensive regulation that addresses anti-money laundering and know-your-customer obligations; segregation of customer funds, disclosure, and other customer protection measures; vertical integration and endemic conflicts of interest; corporate governance and risk-management oversight; independent risk assessment; internal controls; compliance systems; and risks created by reliance on critical third-party service providers.

1. The CFTC’s Jurisdiction Over Digital Assets

There is a need to ensure that the Commission’s regulations keep pace with evolving market structures addressing the new ways in which certain traditional risks arise.[5]

The CEA and Commission’s regulations establish rules for those who operate in our markets and carry out certain activities within our remit.

For example, the CEA requires that, subject to certain exemptions, certain derivative transactions must be conducted on exchanges designated by, or registered with, the CFTC.

Specifically, Sections 5 and 5h of the CEA require exchanges to register with the CFTC as a designated contract market or swap execution facility, as the case may be, if they are providing regulated trade execution services for futures or swaps.[6]

Additionally, Section 4d of the CEA requires registration for intermediaries that act as futures commission merchants—i.e., those that engage in the solicitation or acceptance of orders for, among other things, the purchase or sale of any commodity for future delivery and in connection therewith, accept money, securities, or property (or extend credit in lieu thereof) to margin, guarantee, or secure any trades or contracts that result from such solicitation.[7]

The futures commission merchant registration requirement is fundamental to our regulatory framework, as registered entities must comply with a host of other rules designed to protect customers, such as the segregation of customer assets, the implementation of conflicts of interest safeguards, the adoption of information security and systems safeguards, and the implementation of anti-money laundering and know-your-customer programs, just to name a few.

2. Enforcement of Existing Laws and Regulations: Same Activity, Same Risk, Same Regulation

Over the last several years, the CFTC Division of Enforcement has announced actions in several of the most important investigations and civil enforcement actions in crypto-markets. Markets have witnessed a remarkable rise in fraud enforcement cases involving digital assets as well as enforcement cases charging a violation of the Commission’s regulations.

Last year, nearly 44 of the 59 fraud enforcement actions announced involved transactions in digital assets.[8] The total number of crypto-fraud cases initiated by the Commission nearly doubled year over year as well.

The lack of transparency and visibility into crypto markets enables illicit activity, undermines the integrity of the market, and stymies the development of innovative projects based on the underlying technology which demonstrates potential to engender economic or social benefits.

Recent Enforcement Cases

Binance

Last spring, the Commission announced a civil enforcement action against three affiliated operating entities constituting the digital asset exchange Binance, the CEO of Binance Changpeng Zhao, and the former chief compliance officer of Binance Samuel Lim.[9] At the time, Binance described itself as the world’s largest centralized digital asset exchange.

According to the complaint, Binance offered and executed digital asset spot and derivative transactions for U.S. customers. The CFTC complaint charged that, based on the transactions executed on its platforms, the CEA and CFTC regulations required Binance to register with the Commission and submit to standard regulatory requirements imposed on firms providing similar trade execution, clearing, and settlement services.

The complaint also charged that Binance engaged in a campaign to intentionally avoid being subject to regulation. According to Binance, the global firm was not headquartered in any jurisdiction and did not permit trading by U.S. persons. The Commission alleged that Binance “purported to restrict U.S. customers from trading on its platform, [but] instructed its customers in particular its commercially valuable U.S.-based VIP customers on the best methods for evading Binance’s compliance controls.”[10]

Binance had failed to register with the CFTC and failed to comply with the Bank Secrecy Act and anti-terrorism financing know-your-customer (KYC) and anti-money laundering (AML) obligations. Last November, the Commission announced a proposed consent order under which the defendants “agreed to findings of liability on each of the charges alleged in the complaint, including the first ever charged violation of CFTC Regulation 1.6, governing anti-evasion[11] The order further imposed $1.35 billion in disgorgement and over $1.35 billion in civil monetary penalties.[12]

The many failures in crypto markets illustrate the need for swift action. I want to discuss briefly the various vulnerabilities illustrated by the failure of FTX.

FTX

In December of 2022, in coordination with the Department of Justice (DOJ), U.S. Attorney’s Office for the Southern District of New York (SDNY) and the Securities and Exchange Commission (SEC), the CFTC charged Sam Bankman-Fried, former chief executive officer of FTX; FTX Trading Ltd. d/b/a/ FTX.com (FTX); and Alameda Research LLC (Alameda) with fraud and material misrepresentations in connection with the sale of digital commodities in interstate commerce.

The complaint alleged that from May 2019 to November 2022, Mr. Bankman-Fried controlled both FTX.com, a centralized digital asset spot and derivatives trading platform, and Alameda, a digital asset trading firm that operated as a primary market maker on FTX.

Commingling Customer Assets

FTX held itself out as “the safest and easiest way to buy and sell crypto.” In other words, tapping into the fear of missing out that has characterized certain crypto-investor demographics, Mr. Bankman-Fried and FTX solicited customers on the premise that the FTX platform could be trusted and represented the highest quality standards. Most importantly, FTX promised that customers would control access to the assets in their accounts, had control over those assets at all times, and that those assets were “appropriately safeguarded and segregated” from FTX’s own funds.

The CFTC’s complaint alleges that despite these promises, FTX permitted Alameda to access customer deposits and commingle customer assets with Alameda’s proprietary funds. The complaint further alleges that Alameda and executives at FTX used these funds for its own business operations, personal purchases, acquisitions of other businesses, and for risky investments.

In other words, while soliciting customers to trust in the integrity of its business, FTX is alleged to have engaged in the very business practices that it denounced. The complaint alleged that defendants’ actions caused the loss of over $8 billion in customer deposits.

Conflicts of Interest in a Vertically Integrated Market Structure

In the absence of conflict-of-interest protections, and particularly where there are vertically integrated operational models, customers may be exceptionally vulnerable.

The CFTC complaint in the FTX matter alleged that Alameda operated as a primary “market maker” on FTX, providing liquidity to its various digital asset markets, and also performed a number of other key functions for the exchange. Even when FTX added institutional market makers, Alameda remained a high-volume market maker.

The complaint also alleged that Alameda received preferential trading privileges on its sister exchange. FTX executives created features in the underlying code for FTX that allowed Alameda to maintain an essentially unlimited line of credit on FTX. FTX Trading executives also created other exceptions to FTX’s standard processes that allowed Alameda to have an unfair advantage when transacting on the platform, including quicker execution times and an exemption from the platform’s distinctive auto-liquidation risk management process.

Pernicious and endemic conflicts of interest may be amplified in vertically integrated market structures.

Weak Governance and Risk-Management Framework

Strong governance and risk-management frameworks are key to ensuring the proper functioning of a business. The FTX complaint alleged that Alameda and FTX continued to share office space, first in Berkeley, California and later in Hong Kong and the Bahamas. They also shared key personnel, technology and hardware, intellectual property, and other resources. Bankman-Fried and other senior management at Alameda and FTX also had widespread access to each other’s systems and accounts. Bankman-Fried controlled the FTX entities without adequate governance and risk-management oversight, “a failure of corporate controls” and “a complete absence of trustworthy financial information,[15] and a lack of corporate infrastructure and record-keeping”[16]

In the parallel criminal case, Bankman-Fried was indicted on eight counts, including charges of fraud, money-laundering, and violation of federal campaign finance laws.[17] In November of last year, in a federal courtroom in the Southern District of New York, jurors found Bankman-Fried, guilty of misappropriating billions of dollars in customer funds and assets deposited with and held in the custody by FTX. Bankman-Fried currently awaits sentencing, and prosecutors have requested a prison term of 40-50 years.[18]

3. Need for Regulatory Solution

Only a week after FTX filed for bankruptcy, I delivered a keynote at the annual meeting of the Federal Reserve Bank of Chicago Financial Markets Group in which I emphasized the need for measures that address the challenges that contributed to FTX’s failures.[19]

The speech called for the adoption of:

• internal governance and risk management measures that introduce important know-your-customer and customer identification program obligations,
   
• segregation of customer funds and limitations on the use of customer funds,
   
• conflicts of interest policies designed to address transactions with affiliates.[20]

Three Key Regulatory Principles: Governance Measures, Customer Protection, and Conflicts of Interest

Last year, I delivered a keynote at Duke University’s Digital Assets Conference. There, I repeated my call for the adoption of internal governance measures, protections for customer funds, and policies to address conflicts of interest. I called for “expanding prohibitions on the commingling of customer assets and codifying segregation of customer money from proprietary (house) money”; “implementing financial resources requirements that obligate firms servicing retail markets to maintain sufficient working capital to sustain operations or, in the event of a liquidity crisis, to ensure an orderly liquidation or wind down”; “[e]stablishing requirements for the adoption of conflicts of interest policies”; and “[e]stablishing authority for the Commission to conduct effective due diligence on businesses that seek to buy entities registered with the CFTC.”[21]

Numerous international organizations and standard-setting bodies have spent the last several years studying crypto markets, including the Financial Stability Board (FSB) and the International Organization of Securities Commissions (IOSCO). Both the FSB and IOSCO have issued important recommendations that should inform policy and debate moving forward.

FSB Proposed Framework for the International Regulation of Crypto Asset Activities

Last summer, the FSB proposed a framework for the international regulation of crypto asset activities. The regulation included nine high-level recommendations to promote the consistency and comprehensiveness of regulatory, supervisory and oversight approaches to crypto asset activities and markets. The guidance encouraged consideration of regulatory powers and tools, a general regulatory framework, governance, risk management, cross-border cooperation, coordination, and information sharing, data collection, recording and reporting, disclosures, financial stability risks and crypto asset service providers with multiple functions.

The FSB has called for a crypto regulatory framework “based on the principle of ‘same activity, same risk, same regulation.’”[22] It makes clear the importance of safeguarding client assets, noting that “[m]any crypto-asset service providers [] are observed to extensively commingle proprietary assets with client assets, often without consent of the clients.”[23] It also calls for the mitigation of conflicts of interest, noting that “[v]arious crypto-asset intermediaries combine multiple functions. …Some entities are not transparent about their governance structures and set up complex structures of affiliated entities that often finance each other, leading to acute conflicts of interest and increasing interconnectedness and the risk of contagion within crypto-asset markets.”[24]

IOSCO Consultation

Similarly, IOSCO has issued a report with 18 policy recommendations that cover 6 key areas: (1) conflicts of interest, (2) market manipulation, insider trading and fraud, (3) cross-border risks, (4) custody and client asset protection, (5) operational and technological risk, and (6) retail access, suitability, and distribution.[25] The goal of these recommendations is “to promote greater consistency with respect to how IOSCO members approach the regulation and oversight of crypto-asset activities, given the cross-border nature of the markets, the risks of regulatory arbitrage and the significant risk of harm to which retail investors continue to be exposed.”[26]

As the FSB has noted,

The events of the past year have highlighted the intrinsic volatility and structural vulnerabilities of crypto-assets and related players. They have also illustrated that the failure of a key service provider in the crypto-asset ecosystem can quickly transmit risks to other parts of that ecosystem. As recent events have illustrated, if linkages to traditional finance were to grow further, spillovers from crypto-asset markets into the broader financial system could increase.[27]

As the recent crypto bankruptcies demonstrate, without sufficient customer protection, risk management, corporate governance and conflict-of-interest guardrails, there may be endemic risks in crypto markets. These episodes highlight the need for careful consideration and regulatory oversight.

4. Artificial Intelligence

Another urgent issue I would like to touch on is the rapid advancement in the technologies known as artificial intelligence, or AI. While our markets have long relied upon AI for a variety of risk management and predictive pricing functions, we are witnessing rapid developments beyond reinforcement learning and neural networks in generative AI.

Increasingly, diverse industries and sectors of our economy identify opportunities to integrate aspects of the assemblage of technologies that we commonly describe as AI or AI technologies. AI enables doctors to diagnose and map diseases earlier, faster, and with greater accuracy than ever before in the history of medicine. Farmers who cultivate crops that feed our nation may integrate AI to better manage access to vital resources such as freshwater, enabling more efficient irrigation, fertilization, and crop rotation leading to more sustainable farming.

In our markets, AI offers similar efficiencies for faster trade execution and settlement, more accurate pricing prediction, and more precise risk management oversight. Markets have witnessed increased adoption of AI including AI-driven investment advising, trade execution, risk management, and market surveillance.[28]

It is essential that market regulators such as the CFTC are prepared to respond to the new challenges that AI raises. To that end, the CFTC released a Request for Comment in January, seeking information from the markets regarding current and future uses of AI and the risks that those uses create. This is a great start, though I believe we also must do more.

I am the sponsor of the Market Risk Advisory Committee, and we have launched a Future of Finance Subcommittee that will harness a diverse range of voices to study and propose responses to the new issues that AI raises.

At a Future of Finance Subcommittee meeting earlier this month, I noted that numerous U.S. and international bodies have produced reports with commentary and recommendations regarding the oversight of AI in financial markets.[29]

These efforts include a number of common threads, suggesting that, while many questions remain, there are important areas of consensus regarding the right approach to AI in financial markets. A few of these commonalities include:

A focus on the governance of AI models. FSOC “recommends monitoring the rapid developments in AI, including generative AI, to ensure that oversight structures keep up with or stay ahead of emerging risks to the financial system while facilitating efficiency and innovation.”[30] “Regulators should consider requiring firms to have designated senior management responsible for the oversight of the development, testing, deployment, monitoring and controls of AI and [machine learning]. This includes a documented internal governance framework, with clear lines of accountability.”[31] 

• Promoting the explainability of AI models. Many AI models are “black-box” models, meaning that it may be difficult and in some cases impossible, to explain their decision-making processes. Accordingly, FSOC, IOSCO, the FSB, and FINRA have all emphasized the importance of addressing the explainability challenge.[32] As FINRA put it, [i]ncorporating explainability as a key consideration in the model risk management process for AI-based applications.”[33] 
   
• Data collection, Data Quality, and Data Protection. The need for data controls and data quality, report notes, “data controls like data quality, suitability, security, privacy, and timeliness are vital to sound AI use.”[34] Similarly, FINRA calls for “data governance efforts” including: “data review for potential bias,” “data source verification,” “data integration,” “data security,” and “data quality benchmarks and metrics.”[35] 
   
• Implementing measures to address bias. In 2019, I testified before Congress and voiced my concerns that AI models trained on incomplete or inaccurate data may engender biased results. The White House AI Bill of Rights appropriately emphasizes the need to ensure fairness and guard against bias. In its report, FSOC notes that “specific requirements to prevent discrimination or bias that apply to tools, models, or processes used in consumer compliance also apply to AI. This is an important consideration because without proper design, testing, and controls, AI can lead to disparate outcomes, which may cause direct consumer harm and/or raise consumer compliance risks.”[36] 
   
• Testing and monitoring output. Protecting against bias, promoting explainability, and implementing governance strategies are only possible where models are properly tested and monitored. FSOC, IOSCO, the FSB, and FINRA have each emphasized the importance of testing. FSOC notes the responsibility of financial institutions to “monitor the quality and applicability of AI’s output” – the ability of regulators to “help to ensure that they do so.”[37] Similarly, the FSB recognizes the importance of “[a]ssessing AI and machine learning applications for risks, including adherence to any relevant protocols regarding data privacy, conduct risks, and cybersecurity.”[38] Existing approaches to issues like cybersecurity offer some guidance. Last year, in a statement regarding a proposed cyber resilience rulemaking, I noted the importance of comprehensive regulation in this area, including regulations that capture mission-critical third-party service providers.[39] This last point is particularly important since third-party service providers used by CFTC-regulated entities are unlikely to independently be subject to CFTC oversight. Finally, model testing and oversight, for cybersecurity for example, and much more, must similarly be comprehensive in the parties and the issues that it captures.

In consultation with members of this working group of the Market Risk Advisory committee, I look forward to exploring the ways in which the Commission can ensure that oversight structures keep up with or stay ahead of emerging risks to the financial system while facilitating efficiency and innovation.

The Commission has tools readily available to better understand and address the use of AI in our markets. The Commission also released a Request for Comment in January, seeking information from the market regarding current and future uses of AI and the risks that those uses create.[40] This is a great start, though we must do more:

• The Commission should expand our annual systems examination questionnaire to incorporate a survey of questions that directly inquire about the adoption of AI and related risks in CFTC-regulated markets.
   
• The Commission or staff should issue guidance or advisories regarding their regulatory and compliance expectations with respect to the application of existing CFTC requirements to the use of AI in CFTC-regulated markets.
   
• The Commission should heighten penalties for intentional misuse of AI to facilitate fraud or market manipulation in CFTC-regulated markets.[41]

Heightened Penalties

AI raises new challenges that we must be prepared to respond to. AI may also make certain well-known challenges—like preventing fraud and market manipulation—even more difficult to detect and identify.

To address these concerns, I have proposed for the Commission to consider introducing heightened penalties for those who intentionally use AI technologies to engage in fraud, market manipulation, or the evasion of our regulations. In many instances, our statutes provide for heightened civil monetary penalties where appropriate. I propose that the use of AI in our markets to commit fraud and other violations of our regulations may, in certain circumstances, warrant a heightened civil monetary penalty.

Bad actors who would use AI to violate our rules must be put on notice and sufficiently deterred from using AI as a weapon to engage in fraud, market manipulation, or to otherwise disrupt the operations or integrity of our markets. We must make it clear that the lure of using AI to engage in new malicious schemes will not be worth the cost.[42]

To create heightened penalties, in some contexts, regulators and courts will need to carefully consider the role of intent as an element in misconduct by AI. It may be necessary for our regulations and fraud precedent to affirmatively address questions regarding the intent of trading algorithms as well as algorithms trained to engage in misconduct.

A similar sentiment has been echoed by the U.S. Department of Justice. The DOJ also recently announced enhanced penalties for fraud involving AI misuse (as well as revisions to DOJ’s corporate compliance program guidance to assess AI use).

5. Voluntary Carbon Credits

Another novel asset class presenting similar challenges to crypto and digital assets is voluntary carbon credits. For over a decade, we have recognized the increasing risks that severe climate events create in markets and for critical market participants.

The 2023 United Nations Climate Change Conference, known as COP28, was held in Dubai in November/December 2023. Last year was the hottest year on record. In fact, according to a recent report from the World Meteorological Organization, the past nine years have been the nine warmest years on record, and mean temperatures are now 1.4 degrees Celsius above the average from the second half of the 19th century.[43]

Concentration of greenhouse gases are at record levels and ocean heat is at its highest level in the 65-year observational record.[44] There is much discussion about the use of carbon credits as one tool to mitigate climate disruption, but there are deep concerns regarding the integrity, credibility, and lack of visibility in the market for voluntary carbon credits (VCCs).

I recently noted,

[w]hile the issues and concerns regarding climate risks are endemic, complex, and inherently require multi-lateral solutions effectuated by an international coalition of stakeholders—let’s call it: a coalition of the willing—I strongly believe that financial market regulators and committed market participants may play a pivotal role in developing and implementing some basic, foundational market reforms.[45]

Just a year ago, I visited with the agricultural communities in Kenya to discuss the state of the markets in these important food production and distribution centers in the global economy. In meetings with the then-Governor of the Central Bank of Kenya, I listened to the descriptions of the challenges that emerging economies that rely heavily on agricultural production are experiencing as they navigate severe climate conditions.

Traveling to Central and South America, for over a century, the Panama Canal has provided a convenient way for ships to move between the Pacific and Atlantic Oceans, helping to expedite and reduce the costs of international trade.[46] Insufficient water levels are impacting the flow of transport through the Panama Canal, resulting in shipping delays and increased costs

Responding to these escalating and more frequent severe weather events and other climate risks that increasingly threaten the global economy, voluntary and compliance markets began to offer intangible credits for projects seeking to limit greenhouse gas (GHG) emissions into the atmosphere as well as projects that sequester carbon such as reforestation projects that remove atmospheric carbon. Colloquially, many refer to the voluntary environmental commodities as carbon offsets or VCCs.[48]

A VCC is a tradeable intangible instrument that is issued by a carbon crediting program. Once registered, VCCs associated with a mitigation project or activity may be acquired by end users (businesses or individuals) or intermediaries who act as brokers. While the number of VCC exchanges continues to increase, the spot market for such products remains largely bespoke, with buyers purchasing directly from mitigation project developers or via intermediaries. A carbon credit market creates a forum that enables buyers and distributors to engage in the purchase and sale, respectively, of environmental commodities. Each environmental commodity represents the acquisition or distribution of a credit that contributes to the reduction or sequestration (capturing and storage) of greenhouse gas emissions.

During the last two years, the CFTC has hosted two events—Voluntary Carbon Market Convenings—each a day-long discussion that featured industry- and government-wide participation.[49] In June 2022, the Commission issued a request for information on climate-related risks.[50]

As with crypto assets, while the Commission’s regulatory authority does not reach standard setting for the underlying assets, in this context, carbon offsets, we would have broad anti-fraud and market manipulation authority in the market for carbon offsets.[51] The Commission also has broad enforcement authority with respect to derivatives that reference carbon offsets, and in December 2023, the Commission proposed guidance and a request for public comment regarding the listing for trading of voluntary carbon credit derivative contracts by designated contract markets (and swap execution facilities). The guidance marks a step in the right direction, but it suggests the potential for a broader and more comprehensive framework.[52]

As I have noted,

There are deep and persistent concerns regarding the integrity, credibility, and lack of visibility in the market for carbon credits. Indisputably, challenged efforts to establish universally-adopted and enforceable integrity standards has further stymied attempts to scale carbon credit markets.[53]

Tackling these issues would require much more time than I have been allotted here today, but let me offer a few observations.

Lack of Standardization

Top of my mind as we work to address these concerns is that the market infrastructure for VCCs lacks an effective, universally adopted integrity assessment system.[54] Global coordination is needed to create a harmonized approach to assessing these products, which will ultimately bolster market credibility and confidence. Also concerning is the lack of visibility and integrity in carbon markets.

Greenwashing and Greenclaiming

Greenwashing and greenclaiming all too often involve overinflated descriptions of the environmental benefits of carbon credits and other carbon emission reducing activities.[55] In reality, however, too many of these carbon offset projects offer no environmental benefits at all. A recent study out of the University of Cambridge and ETH Zurich estimates that “88% of the total credit volume across the[] four sectors [of renewable energy, cookstoves, forestry, and chemical processes] in the voluntary carbon market does not constitute real emissions reductions.”[56] Greening claims made in connection with carbon offsets are, for now, unverifiable. Even putting aside cases where an offset might be an outright scam, it is incredibly difficult to know whether a given project actually results in reduced carbon emissions or promised carbon sequestration.

With the current absence of regulation directly addressing greenwashing, I encourage the EFTF to step up enforcement efforts in the meantime. Carbon offsets are viewed as contracts of sale of a commodity in interstate commerce, and thus within the anti-fraud jurisdiction of the CFTC pursuant to Section 6(c)(1) and Regulation 180.1(a).[57] The CME Group lists voluntary carbon emissions offset futures on its exchange, further bringing these products within the ambit of our anti-fraud jurisdiction.[58] The CFTC can and will devote appropriate resources to punishing fraud carried out in these new marketplaces.

Tokenized Carbon Offset Credits

 

The carbon economy has spawned a mirror crypto-economy, in the form of carbonized tokens. And as is the case with much of the crypto-economy, the theoretical goal of carbonized tokens is to make trading of carbon offsets simpler, more transparent, and cheaper, which will enable creators of carbon-reducing projects to access financing more easily.[59] But I have deep concerns that taking one unregulated market—carbon offsets—and layering it on top of another unregulated market—cryptocurrency—will serve only to compound the risks and vulnerabilities inherent in both.[60]

The sheen of new technology-based solutions might entice new and unsuspecting investors hoping to do their part in reducing carbon emissions. With clear guidance on disclosures, governance, auditing, anti-money laundering, data reporting, to name a few issues, there may be hope for offsets to contribute to positive environmental changes. In addition to the steps already taken by the Commission, the Market Risk Advisory Committee which I sponsor has formed a subcommittee focused specifically on climate-related market risk and will be working to engage with these issues this year.

6. Conclusion

The complexity of novel financial products and the emergence of new technologies raise challenges for regulators in the United States and across the globe and expose gaps and overlaps in existing regulatory frameworks. The regulatory framework in the U.S. is characterized by a system of federal regulators and state regulators and umbrella groups that often share authority over the same financial institution. We have seen advancements on these topics at each level without consistent coordination.

The Commission has previously noted in the context of digital assets—but this is equally applicable to VCCs and AIs—that “effective coordination enables regulators to share information, advance common interests, and leverage resources. Coordination efforts also build trust and understanding among regulators.”[61]

This is consistent with one of the recommendations of the FSB, which supports cross-border cooperation, coordination and information sharing. The FSB notes, “[a]uthorities should cooperate and coordinate with each other, both domestically and internationally, to foster efficient and effective communication, information sharing and consultation in order to support each other as appropriate in fulfilling their respective mandates…and to encourage consistency of regulatory and supervisory outcomes.”[62]

Regulatory coordination domestically and internationally is necessary for effective oversight and for the development of a comprehensive, consistent, and harmonized framework, which reduces regulatory arbitrage.

Such coordination and cooperation may take the form of formal agreements, inter-agency working groups, staff-level initiatives, and multilateral organizations.[63]

This Fintech Summit is an example of a step in the right direction, but more work needs to be done.

A comprehensive regulatory framework is essential to achieving the Commission’s mission of ensuring the financial integrity of our markets; avoiding systemic risks; protecting market participants from fraud, abusive sales practices and misuses of customer funds; and promoting responsible innovation in our markets.[64]

Before closing, allow me to thank to my staff Rebecca Lewis Tierney, Julia Welch, and Tamika Bent for their assistance preparing my draft remarks today. Thank you so much for inviting me to join today.

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[1] U.S. Gov't Accountability Off., GAO-13-180, Financial Regulatory Reform: Financial Crisis Losses and Potential Impacts of the Dodd-Frank Act (2013); Kristin N. Johnson, Commissioner, CFTC, Statement Regarding Notice of Proposed Rulemaking Making Amendments to Parts 43 and 45 Swap Data Reporting Technical Specifications (Dec. 15, 2023), https://www.cftc.gov/PressRoom/SpeechesTestimony/johnsonstatement121523.

[2] Kristin N. Johnson, Commissioner, CFTC, Keynote Remarks at Rice University’s Baker Institute Annual Energy Summit (Oct. 5, 2023), https://www.cftc.gov/PressRoom/SpeechesTestimony/opajohnson7.

[3] CFTC, DIGITAL ASSETS PRIMER (2020), https://www.cftc.gov/media/5476/DigitalAssetsPrimer/download

[4] Id.

[5] Id.

[6] 7 U.S.C. §§ 7, 7b-3.

[7] 7 U.S.C.A. § 6d.

[8] Press Release No. 8822-23, CFTC, CFTC Releases FY 2023 Enforcement Results (Nov. 7, 2023), https://www.cftc.gov/PressRoom/PressReleases/8822-23.

[9] See Complaint, Commodity Futures Trading Commission v. Changpeng Zhao, Binance Holdings Limited, Binance Holdings (IE) Limited, Binance (Services) Holdings Limited, and Samuel Lim, Slip Copy, 2023 WL 10448932 (N.D. Ill. 2023).

[10] Id.

[11] Kristin N. Johnson, Commissioner, CFTC, Statement Regarding CFTC’s Landmark Resolution of Charges against Binance and Its CEO and CCO (Nov. 21, 2023), https://www.cftc.gov/PressRoom/SpeechesTestimony/johnsonstatement112123,

[12] Id.

[13] Press Release No. 8638-22, CFTC, CFTC Charges Sam Bankman-Fried, FTX Trading and Alameda with Fraud and Material Misrepresentations (Dec. 13, 2022), https://www.cftc.gov/PressRoom/PressReleases/8638-22; Kristin N. Johnson, Commissioner, CFTC, Statement on Preserving Trust and Preventing the Erosion of Customer Protection Regulation (Nov. 3, 2023), https://www.cftc.gov/PressRoom/SpeechesTestimony/johnstatement110323.

[14] See Complaint, Commodity Futures Trading Commission v. Samuel Bankman-Fried, FTX Trading Ltd d/b/a FTX.com, Alameda Research, LLC, Caroline Ellison, and Zixiao “Gary” Wang, 2022 WL 17884168 (S.D.N.Y. 2022).

[15] Declaration of John J. Ray III at 2, In re FTX Trading Ltd., Hr'g Tr. 156:15-25 (Bankr. D. Del. June 9, 2023) [Case No. 22-11068, ECF No. 1612].

[16] Investigating the Collapse of FTX, Part I: Hearing Before H. Fin. Serv. Comm., 118th Congress (2022) (testimony of Mr. John J. Ray III, CEO, FTX Debtors).

[17] Luc Cohen, Sam Bankman-Fried trial: What charges was he convicted of over FTX's collapse?, Reuters, Nov. 3, 2023, https://www.reuters.com/legal/what-charges-does-sam-bankman-fried-face-over-ftxs-collapse-2023-10-03/.

[18] Matthew Goldstein and David Yaffe-Bellany, Sam Bankman-Fried Should Get 40 to 50 Years in Prison, Prosecutors Say, N.Y. Times, Mar. 15, 2024, https://www.nytimes.com/2024/03/15/technology/sam-bankman-fried-sentencing.html.

[19] Kristin N. Johnson, Commissioner, CFTC, Federal Reserve of Chicago Financial Markets Group Fall Conference, Investing in Investor Protection (Nov. 16, 2022); see also Nahiomy Alvarez, Nomaan Chandiwalla, Alessandro Cocco, 2022 Financial Markets Group Fall Conference–Recap (Feb. 6, 2023), https://www.chicagofed.org/publications/blogs/chicago-fed-insights/2023/2022-fmg-fall-conference-recap

[20] Kristin N. Johnson, Commissioner, CFTC, Keynote Address at Digital Assets @ Duke Conference, Duke’s Pratt School of Engineering and Duke Financial Economics Center (Jan. 26, 2023), https://www.cftc.gov/PressRoom/SpeechesTestimony/opajohnson2.

[21] Id.

[22] Financial Stability Board, FSB Global Regulatory Framework for Crypto-Asset Activities (July 17, 2023) at 1.

[23] Id. at 5.

[24] Id. at 6.

[25] OICU-IOSCO, Final Report, Policy Recommendations for Crypto and Digital Asset Markets (Nov. 2023), https://www.iosco.org/library/pubdocs/pdf/IOSCOPD747.pdf.

[26] Id. at 1.

[27] Financial Stability Board, FSB Global Regulatory Framework for Crypto-Asset Activities (July 17, 2023).

[28] Kristin N. Johnson, Commissioner, CFTC, Opening Statement Before the Market Risk Advisory Committee Future of Finance Subcommittee Meeting (Mar. 15, 2024), https://www.cftc.gov/PressRoom/SpeechesTestimony/johnsonstatement031524.

[29] Id.

[30] Financial Stability Oversight Council, 2023 Annual Report (Dec. 14, 2023),   https://home.treasury.gov/system/files/261/FSOC2023AnnualReport.pdf.

[31] INT’L ORG. OF SEC. COMM’NS BD., THE USE OF ARTIFICIAL INTELLIGENCE AND MACHINE LEARNING BY MARKET INTERMEDIARIES AND ASSET MANAGERS 17 (2021), https://www.iosco.org/library/pubdocs/pdf/IOSCOPD684.pdf (IOSCO Report)

[32] Financial Stability Oversight Council, 2023 Annual Report, supra note 30 at 92

[33] The Financial Industry Regulatory Authority (FINRA), Report on Artificial Intelligence (AI) in the Securities Industry, June 2020, https://www.finra.org/sites/default/files/2020-06/ai-report-061020.pdf.

[34] Financial Stability Oversight Council, 2023 Annual Report, supra note 30 at 92

[35] The Financial Industry regulatory Authority (FINRA), Report on Artificial Intelligence (AI) in the Securities Industry, June 2020, https://www.finra.org/sites/default/files/2020-06/ai-report-061020.pdf.

[36] Financial Stability Oversight Council, 2023 Annual Report, supra note 30 at 92

[37] Id.

[38] Financial Stability Board, Artificial intelligence and machine learning in financial services: Market developments and financial stability implications at 34 (Nov. 1, 2017), https://www.fsb.org/wp-content/uploads/P011117.pdf

[39] Kristin N. Johnson, Commissioner, CFTC, Statement Regarding the CFTC’s Notice of Proposed Rulemaking on Operational Resilience Program for FCMs, SDs, and MSPs (Dec. 18, 2023), https://www.cftc.gov/PressRoom/SpeechesTestimony/johnsonstatement121823.

[40] U.S. Commodity Futures Trading Comm’n, Request for Comment on the Use of Artificial Intelligence in CFTC-Regulated Markets (Jan. 25, 2024), https://www.cftc.gov/PressRoom/PressReleases/8853-24; see also Kristin N. Johnson, Commissioner, CFTC, Statement on the CFTC RFC on AI: Building a Regulatory Framework for AI in Financial Markets (Jan. 25, 2025), Commissioner Kristin N. Johnson Statement on the CFTC RFC on AI: Building a Regulatory Framework for AI in Financial Markets | CFTC.

[41] Kristin N. Johnson, Commissioner, CFTC, Opening Statement Before the Market Risk Advisory Committee Future of Finance Subcommittee Meeting (Mar. 15, 2024), Opening Statement of Commissioner Kristin N. Johnson Before the Market Risk Advisory Committee Future of Finance Subcommittee Meeting | CFTC

[42] Kristin N. Johnson, Commissioner, CFTC, Building A Regulatory Framework for AI in Financial Markets (Feb. 23, 2024), Speech of Commissioner Kristin Johnson: Building A Regulatory Framework for AI in Financial Markets | CFTC

[43] World Meteorological Organization, Provisional State of the Global Climate in 2023 at 2 (Nov. 30, 2023), https://wmo.int/files/provisional-state-of-global-climate-2023

[44] Id.

[45] Kristin N. Johnson, Commissioner, CFTC, All Hat, No Cattle: The Need for Market Structure Reforms in Voluntary Carbon Markets (Nov. 29, 2023), https://www.cftc.gov/PressRoom/SpeechesTestimony/opajohnson9a.

[46] Peter Eavis, Drought Saps the Panama Canal, Disrupting Global Trade, N.Y. Times (Nov. 1, 2023), https://www.nytimes.com/2023/11/01/business/economy/panama-canal-drought-shipping.html.

[47] Id.

[48] Kristin N. Johnson, Commissioner, CFTC, Statement Regarding Policing the (Token) Economy: Introducing Corporate Governance and Market Structure Reforms in Crypto and Environmental Commodities Markets (Nov. 13, 2023), https://www.cftc.gov/PressRoom/SpeechesTestimony/opajohnson8#fnt13.

[49] Kristin N. Johnson, Commissioner, CFTC, Statement Regarding Credibility, Integrity, Visibility: The CFTC’s Role in the Oversight of Carbon Offset Markets (Oct. 5, 2023), https://www.cftc.gov/PressRoom/SpeechesTestimony/opajohnson7#_ftn4.

[50] CFTC, Request for Information on Climate-Related Financial Risk, 87 FR 34856, https://www.cftc.gov/sites/default/files/2022/06/2022-12302a.pdf.

[51] Id.

[52] Kristin N. Johnson, Commissioner, CFTC, Statement on Commission Guidance Regarding Listing of Voluntary Carbon Credit Derivative Contracts (Dec. 4, 2023), https://www.cftc.gov/PressRoom/SpeechesTestimony/johnsonstatement120423.

[53] Id.

[54] Kristin N. Johnson, Commissioner, CFTC, Statement Regarding Credibility, Integrity, Visibility: The CFTC’s Role in the Oversight of Carbon Offset Markets (Oct. 5, 2023), https://www.cftc.gov/PressRoom/SpeechesTestimony/opajohnson7#_ftn4.

[55] Id.

[56] Benedict Probst et al., Systematic Review of the Actual Emissions Reductions of Carbon Offset Projects Across all Major Sectors at 2 (July 27, 2023), https://www.researchsquare.com/article/rs-3149652/v1.

[57] 7 U.S.C. § 9(1); 17 C.F.R. § 180.1(a); 7 U.S.C. § 1a(9) (The definition of the term “commodity” includes “all services, rights, and interests (except motion picture box office receipts, or any index, measure, value or data related to such receipts) in which contracts for future delivery are presently or in the future dealt in.”).

[58] See, e.g., 7 U.S.C. § 9(1) (making unlawful the use of manipulative or deceptive devices “in connection with . . . [a commodity] for future delivery on or subject to the rules of any registered entity”).

[59] Kristin N. Johnson, Commissioner, CFTC, Statement Regarding Credibility, Integrity, Visibility: The CFTC’s Role in the Oversight of Carbon Offset Markets (Oct. 5, 2023), https://www.cftc.gov/PressRoom/SpeechesTestimony/opajohnson7#_ftn4.

[60] Id.

[61] CFTC, Digital Assets Primer, supra note 3.

[62] FSB, High-Level Recommendations for the Regulation, Supervision and Oversight of Global Stablecoin Arrangements (July 17, 2023), High-level Recommendations for the Regulation, Supervision and Oversight of Global Stablecoin Arrangements: Final report (fsb.org)

[63] CFTC, Digital Assets Primer, supra note 3.

[64] 7 U.S.C. § 5.