As the industry moves forward with the broader adoption of digital assets and their supporting technology, the Securities Industry and Financial Markets Association Association (SIFMA) has suggested that further dialogue between industry participants and regulators will help support the further growth of the markets for the security tokens and the adoption of the technology that supports them.
The comments were made in a whitepaper, Security Tokens: Current Regulatory and Operational Considerations for Broker-Dealers and a Look Towards the Future, which was published by SIFMA and PwC, which detailing how distributed ledger technology (DLT) and digital assets such as security tokens interplay with the current securities market.
It outlined the key operational challenges faced by US broker-dealers hoping to adopt this technology and recommended where regulatory clarity would be helpful in addressing these challenges.
Some of the key takeaways from the report included the handling of corporate actions for security tokens in a DLT environment. The paper emphasised that for this, distributions would be made to holders of record according to an ownership log or ledger.
Processes will need to be in place for broker-dealers to transfer or claim to/from other broker-dealers dividends or interest paid on behalf of customers that were owners of record on record date but who have transferred their accounts prior to payable date.
The paper highlighted that systems and processes for handling security tokens will also need to take into account how to allow for the exercise of investor rights such as proxy voting or elections.
Elsewhere, the paper dealt with clearing and settlement where it was noted that post-trade clearing and settlement is an important aspect of the securities trade lifecycle.
Establishing clear and unambiguous transfer of ownership and payment with settlement finality is important for the adoption of security token markets and its success, according to SIFMA and PwC.
They explained: “It is important for industry participants to have confidence in the settlement process, transfer of ownership, payment, and books and records reporting.”
Meanwhile, on the topic of transfer of assets, the paper affirmed with the formation of the DTC as a CSD, most paper certificates were dematerialised with book entry taking the place of physical stock certificates for lower-level intermediaries and beneficial owners.
Due to the current key role of CSDs, many financial institutions’ operational processes and systems revolve around the CSD model. These utilities also provide various benefits to the industry such as CCP netting services, settlement services and risk management of counterparty default.
However, the paper stipulated DLT and security tokens are beginning to challenge this model with the market observing varying implementation models where DLT is being leveraged as a mechanism to act as the registrar that can facilitate transfer with or without an intermediary.
Although SIFMA and its members can see the benefits of these models, their ability to engage with these structures at scale are limited for multiple reasons, it was highlighted.
Despite challenges, the industry supports efforts and continues to engage with regulators to provide clarity, and to work with CSDs to explore how they may service security tokens via application programming interfaces or through other technology.
This, according to the paper, could allow for innovation but also continue to leverage efficiencies existing in current markets.
The paper explored many of the concepts and regulatory frameworks that govern current security markets that may be extended to security token markets with certain modifications.
“We, however, note that many of the legal issues are still yet to be resolved, as market participants, regulators and legislators continue to learn about and understand the use case for security tokens and DLT. As the industry moves forward with the broader adoption of digital assets and their supporting technology, we believe that the areas below will require further dialogue between industry participants and regulators,” SIFMA and PwC stated.
Kenneth E. Bentsen, Jr., president and CEO of SIFMA, commented: “The capital markets are always innovating as technologies develop and the structure of the markets evolves accordingly. Security tokens and related DLT are a prime example of emerging technologies which may have the ability to offer new and cost-efficient methods of capital formation.”
“We hope this whitepaper assists market participants in understanding the potential impacts of security tokens on existing securities regulatory and operational frameworks in the US,” added Bentsen.
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