To Protect Investors and Ensure Safe and Sound Markets

• As recent events have demonstrated, there are significant regulatory gaps that exist in the evolving market for digital assets products and services. It is crucial that policymakers act in a thoughtful but expeditious manner to clarify which existing rules or guidance should apply to these asset classes, and how those rules should be updated to reflect the unique features of blockchain technology.
• In applying existing rules at the federal and state level to digital assets, policymakers should be guided by a set of common principles:
  • Putting investor protection at the forefront of any policy action;
  • Adopting a “technology neutral” approach that follows the “same risk, same activity, same regulatory outcome” principle; and
  • Distinguishing between “blockchain-native” assets and the use of blockchain technology to facilitate “traditional” asset transactions.
• While SIFMA recognizes that there are many open jurisdictional and definitional questions to be resolved, it is possible to identify the types of existing investor protections and corporate governance and disclosure requirements that should be extended to digital asset markets, entities, and products.
• In this blog, SIFMA focuses first on the investor protection benefits that would be derived from extending the existing securities rulebook to digital asset products that clearly meet the definition of securities, as well as to the firms that intermediate those securities transactions. Then we identify a series of core requirements embedded across a range of regulatory frameworks (securities, commodities, prudential, federal, and state) that ought to be applied to all firms operating in the digital assets’ ecosystem, including basic corporate governance standards, financial disclosures, and risk controls.

Addressing Regulatory Gaps Will Promote Investor Protection

Events over the course of 2022 underscored that significant regulatory gaps exist in the digital asset ecosystem, particularly as it applies to crypto assets and certain stablecoin tokens.  While we can debate whether specific rules or regulatory actions would have averted events such as the bankruptcies of FTX or Terra/Luna, the application of clear rules of the road applied broadly to all actors in the digital assets’ ecosystem likely would have mitigated the effects of those events on investors, providing them with the kinds of protections that they have come to expect in traditional financial markets.  It is crucial that policymakers act in a thoughtful but expeditious manner to clarify which existing rules or guidance apply to these asset classes; equally important, they should identify which rules and guidance will need to be updated to take account of these new technologies.

The Core Principles that Should Underpin Efforts to Address Current Regulatory Gaps

As SIFMA outlined in a recent blog post, there are a number of key principles that we believe should guide the efforts of policymakers as they consider these issues:

• Putting investor protection at the forefront of any policy action;
• Adopting a “technology neutral” approach that follows the “same risk, same activity, same regulatory outcome” principle; and
• Distinguishing between “blockchain-native” assets^[1] and the use of blockchain technology to facilitate “traditional” asset transactions.

SIFMA believes that existing, well-developed and broadly understood regulatory frameworks at both the federal and state level should be applied to digital asset-oriented entities and products, with appropriate modifications that reflect the unique features of blockchain technology. Naturally, this raises important questions about which regulatory frameworks ought to apply to specific types of entities and products. Here, policymakers will need to make important decisions around definitional issues. For example, when should digital assets be treated as securities versus commodities? Should stablecoins be regulated as bank-like or securities-like products? How should we distinguish between natively digital assets and securities tokens? There are also a host of related jurisdictional questions: for example, should stablecoin issuers be subject to oversight by a federal prudential regulator or is state regulation sufficient? Where are the exact boundaries between SEC and CFTC jurisdiction? What role should established state regulatory regimes play in oversight of these markets?

In this blog, SIFMA does not propose answers to these open definitional and jurisdictional questions. What we can say is that in deciding which frameworks should apply, policymakers need to bear in mind the diversity of digital asset business models and technology configurations, recognizing that some will align best with securities or commodities frameworks, others with prudential oversight, and that other entities and products can be appropriately regulated at the state level.  Regardless of the framework that is applied, there needs to be emphasis on investor protection, technology neutrality, and the “same risk, same activity, same regulatory outcome” principle – that is regulatory outcomes should be similar for similar activities and similar risks irrespective of the framework that is applied.

Our objective here is to identify at a high-level the types of existing investor protections and corporate governance and disclosure requirements that should be extended to, and updated as appropriate to apply to, digital asset markets, entities, and products.  We first identify a series of core requirements embedded across a range of regulatory frameworks (securities, commodities, prudential, federal, and state) that ought to be applied to all firms operating in the digital assets’ ecosystem, including basic corporate governance standards, financial disclosures, and risk controls Then we focus on the investor protection benefits that would be achieved by extending the existing securities rulebook to digital asset products that clearly meet the definition of securities, as well as to the firms that intermediate those securities transactions.

Common Regulatory Requirements that Should Apply to All Firms in the Digital Asset Ecosystem

Not all digital assets are securities and will, as result, be subject to a variety of different regulatory frameworks at both the federal and state level.  Nonetheless, there are a series of common core requirements already embedded in all of those frameworks (securities, commodities, prudential, federal, and state) that should be applied to participants in the digital assets ecosystem.  For example, while they vary in their specific requirements, these frameworks typically require that market participants meet robust standards of corporate governance, internal controls and oversight, and risk management.  These frameworks also provide investors with confidence that the regulated institutions they work with are safe and secure, and are designed to promote fair and orderly trading in markets.

Policymakers at all levels should work together to ensure certain minimum common standards are applied to institutions that participate in digital asset markets – consistent with the principle of “same risk, same activity, same regulatory outcome.” Whatever the ultimate role of various federal and state regulators in overseeing different types of digital asset businesses and products, investors should be able to expect common minimum standards for how the firms they work with are managed, supervise risk, and safeguard their assets.

Among the common requirements that currently apply to a wide variety of regulated institutions (brokers-dealers, banks, swap dealers, exchanges and utilities), the following should be extended and adapted to apply to firms engaged in digital asset-related activities:

Promoting Investor Protection by Expanding the Existing Securities Rulebook to Cover Digital Assets

Many digital assets likely meet the definition of “securities.” These include a growing number of digital assets that are designed and issued as registered securities, as well as many existing tokens and stablecoins that almost certainly would meet tests used to identify whether a financial product is a security.  The process for determining whether these digital assets are securities is built on the Howey and Reeves tests and supporting case law; SIFMA has explored the issue of how and when digital assets can be defined as securities in greater depth in a prior blogpost.

While securities law will likely not cover all digital assets – for example certain cryptocurrencies including Bitcoin that likely meet the definition of “commodities” but not the tests associated with securities as well as a handful of stablecoins and tokens – the expansion of securities regulatory frameworks to applicable digital assets will offer a range of benefits for investors and for the development of safer, more transparent, and resilient markets.

The securities regulatory framework places investor protection at the forefront, alongside other key regulatory objectives such as market integrity and risk management.  Investor protection is at the core of securities regulation, from the disclosures that accompany securities issuances to the oversight of securities trading, to post-trade regulations that ensure that securities are settled, transferred, and custodied securely on behalf of clients.  This integrated and comprehensive securities regulatory framework has been a core strength for U.S. capital markets for decades, and it has consistently proved itself capable of accommodating new technologies and products.  SIFMA believes that this investor protection focused framework can be extended to new classes of digital assets that meet the definition of securities.

Opportunities to expand and modernize the securities regulatory framework to effectively cover digital assets exist across the securities lifecycle.  As recent events have underscored, there should be a particular focus on extending and updating rules to digital assets in the areas of custody, safekeeping, and segregation of customer assets, such as SEC Rule 15c3-3.  Regulators must provide pathways for firms to meet these custody/segregation requirements using digital asset infrastructure (as discussed in greater depth in SIFMA’s 2021 response to SEC proposals in this area). Similarly, the accounting and capital treatment of firms who custody digital assets should be consistent with existing treatment of custody services, and not create significant hurdles or disincentives for firms who wish to develop secure custody solutions for digital assets, such as those created by the SEC’s Staff Accounting Bulletin 121. SIFMA discussed these issues in a blogpost and associated comment letters.

There are a range of other areas where digital asset products and markets can be incorporated into an updated securities rulebook.  These include in the area of issuer disclosures, where rules should be updated to specify new types of disclosures that reflect unique technological features of digital assets, such as smart contracts or some assets’ dual role as both a security and a utility token.  Similarly, regulators need to address how trading regulations designed to promote fair and orderly markets apply to crypto markets with fundamentally different market structures.  Reporting and recordkeeping requirements may also need to be modified to reflect the new functionality offered by digital ledger technology (“DLT”) information management systems.

Conclusion

As events over the last year have shown, there is a need for policymakers to act to remediate regulatory gaps that exist in the oversight of digital asset markets, entities, and products.  Policymakers should work together at all levels to resolve outstanding jurisdictional and definitional issues, consistent with the principles SIFMA lays out above.  And where jurisdiction is clear, they should work to apply and update existing requirements embedded in their rulebooks to ensure that investors are protected and that firms are subject to common core corporate governance and risk management controls.  In doing so, policymakers at all levels should maintain an open dialogue with firms that have decades of experience in developing products, processes, and operating models that are consistent with these regulations.  Similarly, it is crucial that the perspectives of users of digital asset technology should inform policymakers as they update existing rulebooks to ensure robust investor protection, safety and soundness, and market integrity.

This is part of a series of blogs on digital asset regulation SIFMA will be publishing. The first in the series can be found here.

Charles DeSimone is Vice President, Technology and Operations at SIFMA.

Dr. Peter Ryan is Managing Director and Head of International Capital Markets and Strategic Initiatives at SIFMA. 

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^[1] A blockchain-native asset is issued or created directly on a blockchain network, as opposed to using a blockchain network to trade or track a representation of an underlying asset created elsewhere.