My Crypto Lawyer
Nearly six years have passed since the Commission issued, via authority delegated to the Division of Trading and Markets, its first order disapproving an application by an exchange to list and trade an exchange-traded product (“ETP”) designed to track the price of spot bitcoin.[1] Notwithstanding significant evolution of the bitcoin market, the Commission has continued to disapprove every such filing that has come before it. In our view, the Commission is using a different set of goalposts from those it used—and still uses—for other types of commodity-based ETPs to keep these spot bitcoin ETPs off the exchanges we regulate. Today, the Commission has issued the latest in this disappointing string of disapproval orders.[2] This order’s analysis essentially repeats the analysis that the Commission has given in each of these recent orders. However, it is worth reflecting on the Commission’s approach to these products, how that approach differs from the approach the Commission has taken—and indeed continues to take—toward other commodity-based ETPs, and what this bodes for the future of innovation, and by extension, for investor protection and capital formation, in our markets.[3]
Consistent with its prior bitcoin ETP disapproval orders, the Commission bases its disapproval of the VanEck Bitcoin Trust filing on the inability of the exchange to establish “that it has a comprehensive surveillance-sharing agreement with a regulated market of significant size related to spot bitcoin.”[4] The Commission asserts that this analysis is consistent with its approach to considering earlier rule filings related to non-bitcoin commodity-based ETPs, in which “there has been in every case at least one significant, regulated market for trading futures on the underlying commodity[,] and the ETP listing exchange” has had a surveillance sharing arrangement with that market.[5] Because it finds that the exchange has not established that “it is reasonably likely that a would-be manipulator of the proposed ETP would have to trade on the CME bitcoin futures market to successfully manipulate the proposed ETP,” the Commission concludes that the exchange has not established that that futures market is a “market of significant size” in relation to the bitcoin spot market.[6]
It is true that when approving other types of commodity-based ETPs, the exchange listing such products has had a surveillance-sharing agreement with a market on which futures of the commodity underlying the ETP trade.[7] And those orders typically describe the relevant futures market as “significant.”[8] But it is also clear that the Commission is using a uniquely burdensome definition of “significant” in its analyses of spot bitcoin ETP filings. For example, the Commission has quoted language from its approval orders for other commodity-based ETPs that, it argued, shows that the exchanges seeking these approvals universally had in place a surveillance-sharing agreement with a “significant” futures market.[9] However, the language quoted by the Commission demonstrates that “significant” could not have been referring to the relationship between the futures market and the spot market—indeed, in many of the orders, the Commission draws no connection between the futures market and the spot market. Instead, the Commission’s use of “significant” in the prior approval orders for other commodity-based ETPs appears to refer to the significance, presumably measured by liquidity and volume, of a particular venue for trading futures as compared to the overall market for futures in the relevant commodity.[10]
The spot bitcoin ETP disapproval orders represent a sharp departure from this approach. Rather than look at the size and quality of the relevant futures market to determine whether it is significant, the Commission, beginning in 2018, has insisted that a bitcoin futures market is “significant” for the purposes of determining whether listing and trading a related product only if it meets two conditions:
(a) there is a reasonable likelihood that a person attempting to manipulate the ETP would also have to trade on that market to successfully manipulate the ETP, so that a surveillance-sharing agreement would assist the ETP listing market in detecting and deterring misconduct, and (b) it is unlikely that trading in the ETP would be the predominant influence on prices in that market.[11]
The attentive reader will find no hint that this standard applied in any of the many prior approval orders that the Commission has cited as showing that the “significance” of a regulated market is important in its approval of commodity-based ETPs. Indeed, to establish the authority for applying this standard, the Commission cites only to other previous bitcoin disapproval orders,[12] which indicates that the standard applies only in the context of disapproving spot bitcoin ETP applications. Moreover, although the Commission appears to have included some more direct language regarding surveillance-sharing agreements with significant, regulated markets in its more recent approval orders for other types of commodity-based ETPs,[13] it has not required exchanges proposing to list and trade these products to show that the ostensibly significant market relevant to each filing meets the two-part test it applies to spot bitcoin ETPs.[14]
The Commission has never adequately explained why it has not applied and still does not apply this two-part test when determining whether a futures market related to any other commodity-based ETP is significant. It is true, as the Disapproval Order notes, that the futures markets relating to these other commodities (gold, silver, platinum, palladium, and copper) began trading many years—in some cases several decades—before the related spot commodity ETP was approved.[15] But the age of a futures market would seem to be a poor proxy for whether price formation occurs on the futures market (rather than on the spot market) or for whether the futures market is large enough to ensure that trading in the related ETP would not be the predominant influence on prices in that market, making it difficult to see how it is at all relevant to either prong of the test that the Commission insists spot bitcoin ETP filings satisfy. Moreover, the Commission makes no attempt to show how it is relevant, apparently taking that relevance for granted.
In our view, the Commission should not be applying this two-part test to any commodity-based ETPs, as it is inconsistent with the standard of review imposed by the Exchange Act and is not clearly fit for the purpose for which the Commission is using it. But, given that the Commission continues to use this test in connection with spot bitcoin ETPs, we are puzzled as to why the Commission gives no indication that it has even considered applying the test when it approved more recent commodity-based ETPs. At the very least, the Commission should explain why it has determined that it is not necessary to apply this test to these other products it has approved even after it has determined that a bitcoin futures market cannot be treated as “significant” until an exchange establishes that that market satisfies this two-part test. The Commission has explained neither why it departed from prior practice with respect to analyzing commodity-based ETP rule filings only when faced with spot bitcoin ETP filings, nor why that prior practice remains appropriate when assessing non-bitcoin commodity-based ETPs.
In addition, the Commission has never provided any evidence that any of the non-bitcoin commodity-based ETPs could themselves satisfy the two-part test, or that a lead-lag analysis would show for any other commodity market that price formation typically occurs on the futures market. Without such evidence, it is impossible to know either whether it is reasonable to make this demand of any market or whether, in retrospect, the test would have allowed the Commission to approve commodity-based ETPs that have apparently traded without significant investor harm over the past nearly two decades. Absent evidence that the Commission has established the utility of the test and its connection to the Commission’s stated regulatory objectives, its decision to use this specific test also appears arbitrary and capricious.
We believe that the Commission’s decision to subject spot bitcoin-based ETPs to a bespoke standard that may be impossible for any product to meet has harmed investors by making it harder for the bitcoin market to mature through institutionalization and easier, and potentially safer, retail investor access.[16] But our concern is not just with bitcoin. If we use the test in other markets, we will prevent other products from coming to market. Had we applied the test to other commodity-based ETPs, they might not be trading today. Arbitrarily depriving investors of access to products does not protect them. Consistent application of the standards Congress gave us does.
Importantly, the Commission is required by law to provide an explanation for any change to its policy regarding the approval of commodity-based ETPs.[17] According to the Supreme Court, it would be “arbitrary and capricious” for an agency to enact a new policy that rests upon factual findings that contradict those which underlay its prior policy without providing a reasoned explanation.[18] Additionally, the “requirement that an agency provide reasoned explanation for its action would ordinarily demand that it display awareness that it is changing position.”[19] Here, the Commission has crafted a new standard for determining whether a futures market is “significant.” Not only has the Commission failed to provide an explanation for the change, but it has failed even to acknowledge that there has been a change.[20]
Because we believe that spot bitcoin ETPs should be subject to the same standards the Commission has used for every other type of commodity-based ETP and because we believe the poorly designed test being used here is not fit for purpose and will inhibit innovation—and thereby harm investors—in our markets, we dissent.
[1] See Order Disapproving a Proposed Rule Change, as Modified by Amendments No. 1 and 2, to BZX Rule 14.11(e)(4), Commodity-Based Trust Shares, to List and Trade Shares Issued by the Winklevoss Bitcoin Trust, Rel. No. 34-80206, 82 Fed. Reg. 14076 (Mar. 16, 2017) (issued via delegated authority).
[2] See Order Disapproving a Proposed Rule Change to List and Trade Shares of the VanEck Bitcoin Trust under BZX Rule 14.11(e)(4), Commodity-Based Trust Shares, Rel. No. 34-97102 (Mar. 10, 2023) (“Disapproval Order”) (listing nearly 20 disapproval orders for spot bitcoin ETPs).
[3] Based on a review of exchange filings on the Commission’s website, there appear to be no active spot bitcoin ETP filings currently before the Commission, perhaps reflecting the market’s reasonable conclusion that this Commission will not approve a spot bitcoin ETP, at least not until the SEC has regulatory authority over spot bitcoin markets. See Self-Regulatory Organization Rulemaking, https://www.sec.gov/rules/sro.shtml (containing links to rule filings and related materials submitted by each national securities exchange).
[4] Disapproval Order, supra note 2, at 11.
[5] Id. at 8 (emphasis in original).
[6] Id. at 41. The Commission makes other findings that lead it also to find that the Exchange has not provided sufficient evidence that would give the Commission an alternative basis for finding that permitting the listing and trading of the product is consistent with the Exchange Act. We do not address these findings here.
[8] See, e.g., id.; U.S. Sec. and Exch. Comm’n, Order Setting Aside Action by Delegated Authority and Disapproving a Proposed Rule Change, as Modified by Amendments No. 1 and 2, to List and Trade Shares of the Winklevoss Bitcoin Trust Rel. No. 34-83723, 83 Fed. Reg. 37579, 37592 n. 202 (“Winklevoss Disapproval Order”) (listing prior approval orders and including parenthetical quotations of relevant language identifying various futures markets as “significant”).
[9] See Winklevoss Disapproval Order, supra note 9, 83 Fed. Reg. at 37592, n. 202.
[10] See id. (quoting, for example, one order as noting that “‘[t]he most significant palladium futures exchanges are the NYMEX and the Tokyo Commodity Exchange’”; another as noting that “the COMEX is one of the ‘major world gold markets’”; and another as noting that “‘the most significant gold, silver, platinum and palladium futures exchanges are the COMEX and the TOCOM’”). See also Commissioner Hester M. Peirce, Dissenting Statement of Hester M. Peirce in Response to Release No. 34-88284; File No. SR-NYSEArca-2019-39 (“2020 Peirce Dissent”) (Feb. 26, 2020) (“Tellingly, in none of these pre-bitcoin orders does the Commission appear to have performed any analysis of whether those volumes were significant when compared to the underlying commodity markets. In some prior orders, the Commission does not even mention the size of any related market, much less conduct any analysis of the relevant markets. In at least one case, the Commission approved a rule change to list shares of a product referencing a futures market that, at the time of approval, had no trading whatsoever.”).
[11] Winklevoss Disapproval Order, supra note 9, 83 Fed. Reg. at 37594.
[12] Disapproval Order, supra note 2, at 5, n. 13.
[13] See 2020 Peirce Dissent, supra note 11, at n. 13.
[14] See, e.g., Notice of Filing of Amendment No. 1 and Order Granting Accelerated Approval of a Proposed Rule Change, as Modified by Amendment No. 1, to List and Trade Shares of the Franklin Responsibly Sourced Gold ETF under NYSE Arca Rule 8.201-E (Commodity-Based Trust Shares)), Rel. No. 34-94746, 87 Fed. Reg. 24357 (Apr. 25, 2022) (approving a responsibly-sourced gold ETP); Notice of Filing of Amendment No. 1 and Order Granting Accelerated Approval of a Proposed Rule Change, as Modified by Amendment No. 1, to List and Trade Shares of the Sprott ESG Gold ETF under NYSE Arca Rule 8.201-E (Commodity-Based Trust Shares), Rel. No. 34-94518, 87 Fed. Reg. 18837 (Mar. 31, 2022) (approving an ESG gold ETP). See also Notice of Filing and Immediate Effectiveness of Proposed Rule Change Relating to Listing and Trading of Shares of iShares Gold Trust Micro under NYSE Arca Rule 8.201-E, Rel. No. 34-84881, 86 Fed. Reg. 22996 (Apr. 30, 2021) (notice of immediate effectiveness of rule change to allow listing and trading of physical gold ETP).
[15] See Disapproval Order, supra note 2, at 8, n. 23.
[16] See Commissioner Hester M. Peirce, Dissent of Commissioner Hester M. Peirce to Release No. 34-83723; File No. SR-BatsBZX-2016-309 (July 26, 2018).
[17] See FCC v. Fox Television Stations, Inc. 556 U.S. 502, 515-516 (2009).
[19] Id. (emphasis in original). See also National Cable & Telecomm. Ass’n v. Brand X Internet Services, 545 U.S. 967 (2005) (stating that an unexplained inconsistency is a reason for holding an interpretation to be an arbitrary and capricious change from agency practice).
[20] Fox Television, 556 U.S. at 515 (“agency may not . . . depart from a prior policysub silentio”).
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