SEC staff blocked nine proposed bitcoin-futures funds

The Securities and Exchange Commission’s Division of Trading and Markets disapproved three exchange rule changes covering nine proposed bitcoin-futures exchange-traded products on August 22, 2018.

The delegated orders blocked two proposed ProShares funds, five Direxion funds and two GraniteShares funds from listing on NYSE Arca or Cboe BZX. The decision was consequential because it showed that regulated bitcoin futures, which had begun trading in December 2017, did not by themselves resolve the SEC’s concerns about surveillance and manipulation.

Nine products, three exchange proposals

NYSE Arca sought to list the ProShares Bitcoin ETF and ProShares Short Bitcoin ETF. The first was designed to follow lead-month bitcoin futures listed on the Cboe Futures Exchange or Chicago Mercantile Exchange, while the second sought the inverse of the benchmark’s daily performance.

A separate NYSE Arca proposal covered five Direxion products: one fund targeting inverse daily exposure, three targeting 1.25, 1.5 or two times positive daily exposure, and another targeting two times inverse daily exposure. These were leveraged or inverse futures strategies, not funds holding bitcoin directly.

Cboe BZX proposed the GraniteShares Bitcoin ETF and GraniteShares Short Bitcoin ETF. Amendments filed on August 21 and August 22 would have limited those products to futures traded on the Cboe and CME, removing swaps from the planned portfolios. The SEC deemed the amendments untimely and concluded that they would not have changed the result.

Surveillance remained the central obstacle

Each order applied Section 6(b)(5) of the Securities Exchange Act, which requires a national securities exchange’s rules to be designed to prevent fraudulent and manipulative conduct and protect investors and the public interest.

The SEC did not find that NYSE Arca or Cboe BZX had established a surveillance-sharing agreement with a regulated bitcoin-related market of significant size. Although Cboe and CME were regulated futures markets, the administrative records did not demonstrate that their bitcoin-futures markets were sufficiently large for the proposed products.

Bitcoin futures had traded on those venues only since December 2017. The SEC said that brief operating history gave it no basis to predict how the markets would develop or when they might reach significant size. For Direxion, the order also noted unresolved questions about the proposed funds calculating net asset value at 11 a.m. Eastern, five hours before the regular trading session closed, and the possible effect on arbitrage.

What the orders did not decide

The SEC expressly separated its legal conclusion from an assessment of bitcoin’s merits. It said the disapprovals did not rest on whether bitcoin or blockchain technology had utility or value as an innovation or investment.

The agency also acknowledged that exchange-traded products on regulated securities exchanges could provide investors with protections unavailable in unregulated spot markets. That potential benefit was insufficient because the exchanges still carried the burden of demonstrating compliance with every applicable Exchange Act requirement.

The result therefore was not a general prohibition on bitcoin investment products. It was a rejection of three specific listing proposals on the records assembled by the exchanges. Nor was it a ruling on a spot-bitcoin fund: all nine proposed products sought exposure through bitcoin futures, with some also contemplating derivatives such as options or swaps.

Later context

On August 23, 2018, SEC Secretary Brent Fields notified the exchanges that the Commission would review the delegated staff actions under Rule 431. The review letters stayed the August 22 orders until further Commission action. That next-day intervention was not knowable as part of the August 22 decision itself, but it later changed the orders’ procedural status without approving any of the nine products.