In the latest episode of The SIFMA Podcast, SIFMA President and CEO Kenneth E. Bentsen Jr. is joined by colleagues Peter Ryan and Charles DeSimone to unpack SIFMA’s response to the SEC Crypto Task Force’s request for information on digital assets.

Together, they discuss:

• Key issues raised by Commissioner Hester Peirce’s statement
• SIFMA’s policy recommendations on securities classification, custody, and tokenization – covering both sell- and buy-side perspectives
• The need for clarity, consistency, and technology-neutral rules
• How existing frameworks can adapt to support innovation without compromising investor protection
• And more.

Transcript

Edited for clarity

Kenneth E. Bentsen Jr.: I’m Ken Bentsen, SIFMA President and CEO – welcome to our latest episode of The SIFMA Podcast. I’m joined here today by my SIFMA colleagues Peter Ryan, Managing Director and Head of International Capital Markets and Strategic Initiatives, and Charles DeSimone, Managing Director, Deputy Head of Technology, Operations, and BCP, to talk about SIFMA and SIFMA’s Asset Management Group’s response to the recent Securities and Exchange Commission Crypto Task Force’s request for information from stakeholders on activity involving digital assets. Let’s jump right in.

Peter, let’s start at the top.  The letter was written as a response to an important statement issued by SEC Commissioner Hester Peirce titled “There Must Be Some Way Out of Here.”  What was the motivation behind the Commissioner’s statement, and what were its key points? And what issues is SIFMA most interested in?

Peter Ryan: Well, to provide some context, it is useful to go back to the start of the presidential transition in January. One of the first acts of the then newly appointed Acting Chair Mark Uyeda was to create a “Crypto Task Force” under the leadership of Commissioner Peirce. The goal of the Crypto Task Force, which is comprised of staff from across the SEC, is to develop recommendations for a new regulatory framework for digital asset activity in the securities sector with the objective of providing greater clarity for market participants and promoting innovation in the digital assets sector.

On February 21^st, Commissioner Peirce released the statement that you referenced. The statement contains a request for public information or RFI consisting of 48 questions on a variety of topics that the Crypto Task Force is examining as part of its work. In the statement, Commissioner Peirce makes clear that the Task Force – and indeed the Commission – is looking to “make rapid progress” and encouraged respondents to get feedback to the Task Force in a timely manner. And that has certainly happened – in addition to our own first phase submission, approximately 150 written responses have been shared with the Task Force to date, in addition to the four public roundtable discussions that they have held since March and numerous meetings with various stakeholders.

The RFI itself covers a wide range of topics of particular interest to SIFMA and its members.

The first bucket of questions are designed to obtain feedback on how and when certain types of digital assets should be categorized as “securities,” and conversely, how the SEC should go about “scoping out” other types of non-security digital assets. These are important foundational issues, and both SIFMA and our global affiliate, the GFMA, have done a lot of work to develop clear taxonomies and classification approaches, as we’ll talk about.

The next set of questions deal with the issuance and registration of digital securities, as well as the potential for a limited “safe harbor” from normal securities registration requirements under certain circumstances. Another bucket of questions deals with issues related to secondary market trading of crypto assets, where much of the focus is on asking how the Commission should regulate platforms and market participants that trade securities alongside non-securities. These issuance and trading issues are core to our work at SIFMA and are also a focus of pending market structure legislation being considered at the congressional level right now.

A large fourth body of questions seeks answers on how custody requirements for broker-dealers, investment advisers, and investment companies may need to be updated to enable the safekeeping of client digital assets, and  SIFMA has already made a wide range of recommendations that would provide greater regulatory clarity to the safekeeping of digital assets. Beyond this, the RFI also seeks feedback on the regulation of crypto lending and crypto exchange-traded products, and poses questions related to tokenized securities, including questions around settlement of such securities – another area where SIFMA and the GFMA have done a lot of work.

Finally, Commissioner Peirce asks for feedback on the idea of “regulatory sandboxes,” including cross-border sandbox. Such sandboxes would enable firms to explore different digital asset use cases on a small scale without having to comply with the full panoply of securities regulations.

Bentsen: That’s a lot. As noted, we filed one submission and are preparing a second submission. We have made a number of suggestions overriding principles for any new law, regulation, or guidance impacting digital asset activity in the securities sector.  Charles, can you walk us through those – what are they and why?

Charles DeSimone: I’d be happy to. At a fundamental level, while the technology used for digital assets in the securities markets may be new, the economic realities underlying digital assets transactions are very similar to those that shape the traditional capital markets. And so any new regulatory frameworks which govern digital assets activity should be designed with an eye to our the established regulatory frameworks – both to ensure that digital asset markets meet the same standards of market quality and investor protection we have today, to build off the experience the industry and regulators have developed, and to ensure a level playing field across different types of technologies. Perhaps foremost is remembering the importance of establishing robust investor protections. The same robust investor protections that have long underpinned the strength of the U.S. securities markets must be extended to digital asset market participants.

Second, while the blockchain technology is new, the role of regulations in protecting investors, ensuring safety and soundness, and market quality is well established. We encourage regulators to build on existing regulatory principles. To the extent possible, regulators should apply existing and well-understood securities regulatory principles to digital assets, rather than creating a distinct architecture only for this class of assets and transactions.

While these assets may have novel technological features, the core goals of regulation remain the same. Given that we are still in the early stages of the development of digital asset markets, SIFMA encourages the SEC to focus primarily through the issuance of flexible, principles-based guidance following engagement with market participants, rather than through prescriptive, technologically driven mandates. While we are adopting regulation to the impacts of new technology, it is important to apply a technology-neutral approach. What this means is that rules, guidance, and other policies should broadly be “technology neutral” and should focus on the underlying risks of a given asset or transaction rather than the underlying technology that is used. This is important so regulation is not locked into a point in time view of rapidly evolving technology.

Finally, it is critical to make sure that new frameworks do not create opportunities for regulatory arbitrage. Policies should follow the “same risk, same activity, same regulatory outcome” principle, ensuring that digital assets and market participants are subject to regulatory outcomes that are risk-appropriate and broadly equivalent to those that apply to traditional assets and market participants.

Bentsen: So, our recommendations in this “first phase” response cover three main areas: securities status, custody, and tokenization. Let’s discuss each of those in turn. Peter, could you get us started?

Ryan: Sure thing. Our initial response focuses on areas where we have done a significant amount of work to-date, beginning with the question of how and when a digital asset should be classified as a “security,” and how the SEC should go about scoping out certain assets.

Here we made a number of key recommendations. First, we recommend that the Commission adopt clear, consistent and consensus-driven taxonomies and classification approaches, which we see as a crucial first step in the development of effective digital assets regulation. Specifically, SIFMA recommends that the SEC consider an approach developed by the GFMA, and endorsed by the CFTC’s Global Markets Advisory Committee. This taxonomy has the advantage of having been widely vetted by a diverse group of market participants and can be universally applied across different jurisdictions and regulatory frameworks, making it a good basis for any SEC classification scheme.

Moreover, we say that any taxonomy approach that the SEC adopts should allow market participants to classify digital assets into categories in a way that does not result in varying outcomes based on factors extrinsic to the asset. This would allow market participants to readily classify digital assets into financial assets that are securities, money-like digital assets such as stablecoins, and cryptocurrencies, as well as other types of alternative and functional digital assets and electronic settlement records. When we say “extrinsic to the asset,” here what we really mean is that securities status should not be determined by mutable or variable technological characteristics, such as whether the underlying network it operates on is a private or public network. Instead, we recommend in our response that the securities status of a particular asset or a transaction should be based on its economic characteristics and on the legal relationships that it creates with the issuer of the token.

We also recommend that the SEC build on the very deep reservoir of case law in determining securities status, and supplement it where needed through the issuance of flexible, principles-based guidance and FAQs. Guidance is particularly helpful in areas where technology and related applications introduce new processes and involve functionalities that go beyond existing market activity. For example, in areas such as the staking of digital assets to secure a blockchain network and running a computer node on a network to validate transactions.

In this same vein, our response expresses support for the SEC’s efforts over the last few months to provide guidance and FAQs to market participants. This includes guidance that clearly scopes out certain types of non-securities digital assets and digital asset activities, examples of which include the recent staff statements on “covered stablecoins” and certain proof-of-work mining activities. However, consistent with the core principles that Charles spoke about, any guidance should be a technology-neutral approach. It is also important, to the extent possible, to avoid adopting classifications that may create conflicts with terminology either being adopted by other regulators or being considered as part of the pending stablecoin and digital asset market structure bills in Congress.

Bentsen: And what about custody?

Ryan: We spent a lot of time discussing our views on the custody of digital asset securities in the letter, which is reflective both of the fact that custody is foundational to the development of mature digital asset markets and given that SIFMA has been very involved in thinking about digital asset custody issues over the past several years. While the SEC took an important step in providing regulatory clarity by repealing Staff Accounting Bulletin 121 in January, there is still more that needs to be done, as we outline in our letter.

At a general level, we make clear on our response that traditional regulatory principles around custody and the role of the custodian, including the separation of financial activities, segregation of client assets, and ensuring proper control of assets, should be applied to the custody of digital assets, whether in the broker-dealer, registered investment adviser (“RIA”), or investment company context. In our view then, the Commission should rely on existing regulatory frameworks governing custody rather than adopting entirely new rulesets just for digital assets.

For example, we strongly oppose the SEC moving forward with its unworkable 2023 safeguarding and safeguarding advisory client assets proposals. Instead, we recommend that the SEC should engage in an iterative dialogue with industry participants to develop updated guidance explaining how existing rules apply in specific areas of digital asset activity. Examples of this would be guidance around the control of “private keys” that are used to give transfer instructions for digital assets, as well as guidance related to the conduct of various activities, such as staking and voting.

As we note in the letter, a dialogue with market practitioners would also help the Commission better understand how core custody requirements around “physical” or “exclusive” possession or control could be applied to different types of digital assets. Consistent with our “same risk, same activity, same regulatory outcome” principle, we recommend that all qualified custodians be subject to the same standards. So, the extent that the SEC is considering widening the definition of qualified custodians to permit new types of entities to custody digital asset securities, those entities must meet the same level of regulatory obligations and investor protections as existing qualified custodians, including the customer protections enumerated under Rule 15c3-3.

In the letter, we also reiterate that any custody requirements for digital assets should be technology-neutral and not take an approach to regulating different network configurations that would favor specific technological characteristics such as the network type itself (private vs. public) and the configuration of the network (permissioned vs. permissionless).

We further note the importance of the SEC coordinating its approach with that of other primary regulators of market participants, including the CFTC and prudential regulators, so that they can permissibly function as custodians under current SEC regulations. As we discuss, a lack of coordination would lead to unnecessary complications, potential regulatory arbitrage, and inhibit the growth of these markets.

In terms of more specific recommendations, SIFMA has long highlighted the unworkability of the SEC’s Special Purpose Broker-Dealer framework. To that end, we welcome the FAQs recently released by the Commission staff clarifying that compliance with the SPBD statement is no longer mandatory, as well as recent remarks by Chairman Atkins indicating an openness to rescinding and replacing the framework. In the letter, we urge the SEC to formally withdraw the SPBD statement as soon as possible and replace it with a framework that would enable all broker-dealers to custody digital asset securities alongside traditional assets within their established entities.

When it comes to digital assets that are not securities, our view is that the SEC should carefully assess its existing authorities in consultation with other regulators and avoid prescriptive mandates that may be difficult or impossible for custodians to implement. Again, we believe that any rules or guidance should also be technology-neutral and treat the non-security digital asset in the same manner as a traditional asset with the same economic function.

Finally, among other things, we recommend that the SEC adopt a consistent and narrow definition of “self-custody,” which we see as impracticable for most institutional investors given the security risks and operational complexities of digital wallets; potential conflicts of interest and investor protection requirements; and given the practical convenience provided by an indirect holding system managed by third party entities. We also make recommendations relating to the treatment of custodial relationships under state law and suggest that the SEC clarify via guidance that blockchain-only records can be used to satisfy existing broker-dealer recordkeeping requirements.

Bentsen:  Charles, what about tokenization? We’ve done a lot of work here at SIFMA on that issue, and you’ve led a lot of that work – what are our key points there, and particularly with regard to settlement?

DeSimone: Compared to some of the other areas we talked about today, there are fewer regulatory challenges associated with tokenization. This is partly because many of the foundational questions about tokenized securities are clear – they are issued as securities, but are represented on a blockchain. While there are some distinctions between digital asset securities which were issued onto a blockchain – what are called natively digital securities, versus those which are issued traditional but are represented on-chain – so-called tokenized securities – both are clearly securities legally. Since it is clear that tokenized securities are securities, just represented in a new way – similar to how securities recorded in computer systems today and paper securities, a key next step for regulators is to ensure that established securities regulatory frameworks let firms work with tokenized securities as they would any other type of security.

One key challenge has been meeting possession and control requirements – the regulations that shape how brokers demonstrate that they are safely holding their clients’ assets.  Peter discussed the progress that’s being made to resolve the challenges, the SPBD framework created and how it was a major obstacle to tokenized securities operations. There are a range of other rules governing how securities are held, traded, cleared, and how information on them is managed of the which were written in a different technological environment.  We need to get regulatory clarity that firms can meet these requirements even when the processes used for blockchain systems are slightly different, but the end result is the same.

For example, the SEC should confirm formally that firms can meet their obligations to maintain records on securities transactions using blockchain systems. Similarly, a number of processes which occur after a trade is completed – clearance and settlement activities – can be handled differently for tokenized securities.   This can unlock a lot of efficiencies, reduce risk, and allow for development of new products and services. We would like to provide a clear pathway for firms to meet regulatory requirements for these post-trade activities.

Last year SIFMA completed a major project, the Regulated Settlement Network, or RSN, exploring how tokenization can drive innovation in the securities settlement space. We identified a number of open regulatory questions associated with these activities, which we would like to get clarity on.

Finally, we want to caution that while tokenization can drive many innovations in securities trading and settlement, it does not provide a basis to move the securities settlement cycle as a whole faster than the T+1 cycle we have today. While some firms may choose to use a faster settlement cycle on a voluntary basis for some transactions, the market as a whole is dependent on a range of products and processes  -prime brokerage, securities lending, financing, among others – which can’t be executed on a same-day basis.

Bentsen: Peter and Charles, thank you for that good discussion of the first iteration of our response to the SEC, as far as their RFI, but as noted, SIFMA is working to provide additional comments soon on the issuance and trading topics raised in Commissioner Peirce’s statement. Charles, can you provide us with a preview of our comments and also talk about how they also relate to some of the important issues being considered as part of potential digital asset market structure legislation?

DeSimone: Happy to – broadly our work is focused on the issuance of native digital assets and their trading. Previously, Peter mentioned the “same risk, same activity, same regulatory outcome” concept. That idea is really at the core of how we approach these issuance and trading issues. Securities markets – and capital markets more broadly – are shaped by a set of regulations, business practices, and roles of intermediaries that have evolved over decades to protect investors, manage risk, and ensure high-quality markets.  As market participants, investors, and regulators look to develop digital asset markets, we want to make sure we are carrying over those protections to any new products or trading models.

For example, while there are a range of pathways for securities to be issued today, they all come with appropriate registration and disclosure requirements to help investors understand what they are buying.  Any new pathways for digital assets to be issued would need to preserve equivalent disclosures, perhaps supplemented with additional information about their technology configuration that may be germane to potential buyers. Expanding and modernizing existing SEC securities issuance frameworks will help drive digital asset issuance activity through these channels that have mature disclosure and oversight framework. Of course, we recognize that not all digital assets will meet the legal definition of a security.  In that case, it will be important to ensure that whatever framework those assets are issued under mirrors those foundational disclosure requirements.

Similarly, on the trading side, exchanges and alternative trading systems are governed by a set of regulations designed to manage conflicts of interest, mitigate risk, and promote high-quality markets. We recommend the core concepts of those regulatory frameworks be applied to any emerging digital asset trading venues.  Some of these key concepts include separation of functions (so that an exchange entity is not also a broker-dealer or a custodian), rules governing trading, such as order protection and transparency, transparent governance procedures, and interoperability so firms are not chained to specific providers. There is a lot of work to do in understanding how these concepts can be applied to emerging digital asset trading models, but they have served investors in the securities markets well, and we want to see the same levels of protection carried over.

Bentsen: While we have focused on our response to the SEC RFI today, SIFMA has also been active in thinking about other issues in the digital assets space. Peter, can you walk us through some of the other issues we have been focused on?

Ryan: One area that we have been focused on is providing feedback on the pending payment stablecoin bills in both the Senate and the House. In general terms, we have supported a viable federal and state, as well as a bank and non-bank pathway, for firms to become payment stablecoin issuers, so long as there is broad comparability between the regimes, consistent with our “same risk, same activity, same regulatory outcome” principle. We have also recommended for the application of tailored, risk appropriate capital and other prudential requirements for payment stablecoin issuers, as well as permitting highly liquid and creditworthy funds to count as eligible reserve assets for payment stablecoin issuers. Beyond this, we have advocated for the inclusion of strong custodial and illicit financing requirements in the bills.

Another area where we have been active has been in ensuring that banking organizations can permissibly engage in digital asset activities. To this end, in February we wrote a letter jointly with a number of other financial services trade associations calling on the banking agencies to rescind and replace a number of pieces of guidance that had effectively prevented banks from engaging in a variety of digital and crypto asset activities; to-date, almost all of the policy and guidance documents that we identified have been rescinded. We followed this up with a second joint letter in early May calling on the agencies to take the next step and issue clear, technology-neutral guidelines for how and when banks may safely and soundly engage with digital and crypto asset activities in the future.

And then finally, in addition to all of this, we are continuing to work with members and other trade groups on how different types of crypto asset exposures should be treated for the purposes of bank capital requirements.

Bentsen: Thanks Peter and Charles. There is clearly a lot for us to talk about in this area. We hope you found these conversations as valuable as we did. Comments and questions are welcome; listeners can reach us via email at [email protected].  More information on our views on crypto and digital assets is available at our website at www.sifma.org. Thank you for listening in today.

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Related Resources

• SIFMA Letter

  Request for Comment on Statement by Commissioner Hester M. Peirce Re: Crypto RFI

• Commissioner Hester M. Peirce Statement

  There Must Be Some Way Out of Here