New York, NY, June 14, 2023 – In a comment letter filed with the SEC, SIFMA broadly supports the policy goal of ensuring that rules governing trading venues keep pace with technological and market developments but remains concerned that the SEC’s proposal to redefine the scope of what constitutes an exchange and expand Regulation ATS is not appropriately tailored to these ends.  In a separate comment letter, SIFMA’s Asset Management Group (AMG) likewise expresses its appreciation of the SEC’s intent to support well-functioning markets, but absent the clear identification of a problem not already well-addressed by existing regulations, SIFMA AMG has serious questions and concerns about the potential for an expansive interpretation as to the scope of these changes.

The comments were made in response to an SEC release which provides supplemental information and reopens the comment period for the SEC’s January 2022 proposal to amend Rule 3b-16, which defines exchanges, and Regulation ATS, which is the regulatory regime that governs alternative trading systems.  The proposal would expand the scope of the rule to include systems that offer the use of non-firm trading interest and provide protocols to bring together buyers and sellers for trading any type of security. These so-called communication protocol systems would be required to either register as exchanges or register as broker-dealers and comply with Regulation ATS.

As stated in prior comment letters on the proposal, filed in April 2022 and June 2022 by SIFMA and in April 2022 by SIFMA AMG, both the scope of proposed Rule 3b-16 and the SEC’s rationale for expanding its interpretation of an exchange remain unclear.

“We are concerned that, by attempting to bring decentralized finance (DeFi) systems within the scope of Rule 3b-16 and Regulation ATS, the SEC may also subject many non-DeFi systems to regulation as an exchange without a clear rationale,” said Rob Toomey, SIFMA head of capital markets and managing director.  “If DeFi systems are the primary focus of the SEC’s efforts, it would be more appropriate to propose separate rules tailored to the specific functioning, risk profile, and complexities of DeFi systems specifically—rather than ballooning existing rules in a way that would also improperly scope in a multitude of other broker-dealer systems that the SEC says it does not want to capture.”

“The SEC proposal makes a number of changes to an existing regulation that has functioned very well,” said Bill Thum, managing director and associate general counsel, SIFMA AMG.

“The broad drafting of the proposal, even with the more recent clarifications, suggests a dramatic expansion of regulatory scope and obligations – in ways unrelated to a data-driven identification of problems requiring attention – and the risk of such an expansion of scope and obligations presents troubling consequences.”

SIFMA’s comments on the reopening of the proposal include the following points:

• The Proposal continues to lack conceptual coherence and a clear rationale for the significant expansion of Rule 3b-16. SIFMA remains concerned that the proposed interpretation of an “exchange” lacks conceptual coherence and has become untethered to how actual exchanges operate.  The SEC has not provided a clear rationale for why many systems, such as those used for negotiation, are appropriately considered exchanges and why a major expansion of Rule 3b-16 is necessary.  This leads to an inconsistent and arbitrary application of Rule 3b-16.
• The SEC should pursue an incremental approach toward the expansion of Rule 3b-16 and Regulation ATS. SIFMA believes the SEC should take an incremental approach to any expansion of Rule 3b-16 and Regulation ATS, such as by first extending Regulation ATS to systems supporting trading in government securities pursuant to the originally proposed Form ATS-G.  Further industry comment and discussion (e.g., through roundtables or a concept release) are needed to ensure that any amendments to Rule 3b-16 would be appropriately calibrated to capture systems that should be subject to the exchange/ATS regulatory framework while excluding those broker-dealer systems (e.g., order and execution management systems) that should be excluded from such framework.
• The SEC has not addressed numerous questions from commenters unrelated to DeFi. The SEC has not addressed numerous questions from commenters including SIFMA unrelated to DeFi, resulting in lingering confusion and ambiguity in the proposed application of Rule 3b-16.
• The proposed scope of Rule 3b-16 remains vague and overbroad. The DeFi Release has exacerbated confusion and ambiguity in the proposal in particular with respect to the still undefined term “communication protocol system.”  To help mitigate these issues, SIFMA believes the SEC should separately propose rules to address DeFi systems rather than expanding Rule 3b-16.  It is also difficult to comment meaningfully on the proposal, as amended by the DeFi Release, given the sea of choices of different proposed Rule 3b-16 text the SEC has now proposed.  At a minimum, substantially greater clarification and clearer lines need to be drawn between in-scope and out-of-scope systems as well as clarification regarding how certain systems would comply with Regulation ATS.
• An extended compliance period would be necessary for market participants to comply with any adopted proposal.  A significantly longer compliance deadline (i.e., at least 24 months) would be necessary for market participants to come into compliance with any adopted rules.

SIFMA AMG’s comments include the following points:

• “Non-discretionary” must be clearly defined as being key to the definition of an “Exchange”. “Exchange” treatment must not apply if the user has discretion: (1) to select potential counterparties and (2) to select the preferred order/response.
• Proposed amendments are insufficient to narrow the scope of the systems intended for “Exchange” treatment. While terms like “establishes” and “negotiation protocols” appear more likely to be interpreted as closer to the mark, there remains too high a degree of ambiguity, and this drafting exercise avoids the most critical issue – the need to provide certainty for the use of the term “non-discretionary.”
• OEMS systems and ETF portals lack key components of an “Exchange”. OEMS and ETF portal systems have been carefully developed by a diverse group of market participants to introduce efficiencies and cost savings into the market – but do not allow for separate users to interact and do not directly connect with multiple brokers to confirm the non-discretionary execution of orders.
• Explicitly carve out OEMS systems and ETF portals from treatment as an“Exchange”. Not only would this avoid the risk that such systems could ultimately be found to qualify for “exchange” treatment, but almost more importantly such a carve-out would eliminate any risk of developers abandoning innovations designed to achieve greater efficiencies and cost-savings for the benefit of investors.

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SIFMA is the leading trade association for broker-dealers, investment banks and asset managers operating in the U.S. and global capital markets. On behalf of our industry’s one million employees, we advocate on legislation, regulation and business policy affecting retail and institutional investors, equity and fixed income markets and related products and services. We serve as an industry coordinating body to promote fair and orderly markets, informed regulatory compliance, and efficient market operations and resiliency. We also provide a forum for industry policy and professional development.  SIFMA, with offices in New York and Washington, D.C., is the U.S. regional member of the Global Financial Markets Association (GFMA).