SEC proposes exemption for tokenizing digital securities

Yesterday, Commissioner Hester Peirce of the Securities and Exchange Commission (SEC) announced that the SEC is looking into creating exemptions to support the issuance, trading, and settlement of securities using Distributed Ledger Technology (DLT). This move is inspired by sandbox environments offered in other jurisdictions.

Traditionally, the SEC has issued no action letters to specific entities. Commissioner Peirce mentioned the possibility of implementing an exemptive order that would enable companies to utilize DLT for securities transactions without the need for full registration. While regulators claim to be technology-neutral, existing laws are often based on outdated technologies, potentially hindering the benefits of emerging technologies like DLT.

There is a dilemma in the industry where companies are hesitant to undergo the costly process of registering as a broker-dealer, exchange, or clearing agency due to the small size of the tokenized securities market. Simultaneously, the market will not grow significantly without the presence of secondary markets for these tokenized securities.

Commissioner Peirce emphasized the need for the SEC to adapt its rules to accommodate DLT. Sandboxes have been successful in other countries, with initiatives like the UK’s Digital Securities Sandbox (DSS) showing promising results. The DSS has implemented entity-specific volume limits to cater to entities of varying sizes and levels of experience.

Regulations in these sandboxes include requirements related to market integrity, disclosure of smart contract risks, record-keeping, financial resources, custody transparency, and oversight by the SEC. Commissioner Peirce highlighted the importance of principle-based disclosures, focusing on material issues rather than detailed checklists.

The goal of these proposed changes is to create an approach that protects investors while leveraging advanced technologies for securities trading, clearing, and settlement. Commissioner Peirce expects to gather valuable feedback at the SEC’s Tokenization Roundtable event next week. This event will likely involve discussions around collaborations with other jurisdictions to facilitate the growth of tokenized securities markets.

Overall, the SEC’s consideration of exemptions for tokenization and DLT-based securities reflects a proactive approach to regulatory adaptation in response to technological advancements in the financial sector. This move could potentially open up new avenues for innovation and growth in the securities market while ensuring investor protection and market integrity.