Earlier this year, the U.S. Securities and Exchange Commission (SEC) launched a proposal with plans to update its regulations as it pertains to cryptocurrency. The statement, issued on the Commission’s official website, laid out ten key areas that will see changes.
Crypto market news is abuzz with what that could mean for the crypto market as a whole. With the SEC aiming to clarify the classification of crypto assets, improved regulations could lead to significant circumstances as it pertains to the value and future of the investment.
SEC Seeks to Provide Clarification of Crypto Asset Classification
The Commission is aiming to create specific rules meant to define how crypto assets are categorized. A classification system will need to be developed to clarify those crypto assets and to determine which coins or tokens will qualify as securities. The entire goal is to create exact rules that remove regulatory uncertainty while also fitting market needs.
Token and coin offerings will undergo a strict evaluation. The aim of the SEC will be to prevent misleading investment opportunities while also increasing overall transparency. The SEC aims to simplify the registration process (including crowdfunding and Regulation A), to encourage market participation and overall compliance within the industry.
Rules for Crypto Staking, Lending, and Custody
The main focus of the SEC is to improve regulations as it relates to the custody of crypto assets. The SEC is expected to issue a statement that will clarify the role of broker-dealers when it comes to the handling of both securities as well as non-securities. Updated guidelines on digital asset currency will also be provided to investment advisers.
Existing financial laws will also help determine how crypto staking and lending services operate. A review guarantees that all operations will adhere to specific financial legislation. The SEC will focus on regulating those activities in order to safeguard current and future investors from potential risks. It is anticipated that new exchange-traded products (ETPs) could enter the market after the new regulatory framework is in place.
Regulations on Transfer Agents and Clearing Agencies
Another goal of the SEC is to establish clear rules as it pertains to clearing agencies that work with processing crypto transactions. The regulations would work to improve efficiency and reduce operational risks within the market. The SEC is also looking to enhance oversight of transfer agents that handle digital assets.
Also under consideration is a cross-border regulatory sandbox. The move would allow crypto projects of an international variety to test operations within controlled conditions. The Commission believes that this is the kind of approach that will support not only global regulatory cooperation but foster innovation as well.
Notable Points and Observations from SEC Proposal
Registered Investment Advisors (RIAs) will find beneficial an overview of the most notable points and observations from the SEC’s recent proposal. Let’s take a quick look at each of the most important points and what they could mean.
Safeguarding Rule
The Custody Rule proposed by the SEC would apply only to securities and cash of advisory clients of which an advisor has custody. The Safeguarding Rule would apply to all assets like crypto, real estate, and derivatives. The lone exception would be for “privately offered securities” that would be applied and be maintained to all assets.
In writing, the adviser would be required to document that a qualified custodian may not record and maintain those assets. Also, the adviser will be tasked to reasonably safeguard those assets.
Discretionary Authority
Under the proposal, RIAs would not be able to limit their ability to direct their custodians to transfer or disburse securities and cash in order to avoid triggering the aforementioned Safeguarding Rule.
The proposal would capture advisors whose authority over client assets is entirely discretionary and limited to instructing custodians to transact in assets that will only settle on a delivery versus payment basis. There would still be significant practical challenges for swaps, prime brokerage, and other trading activities of RIAs.
No Flexibility for Crypto Assets
Under the proposal, crypto assets would be treated just as any other asset while also being subject to the Safeguarding Rule. This includes using qualified custodians that have control or possession of those crypto assets.
Some custodians and crypto assets will offer compliant solutions, but the new requirements would present some practical challenges.
New Requirements for Custodial Arrangements
Qualified custodians will need to have control or possession over client assets. Advisers would be required to sign written agreements and also to obtain reasonable assurances from a qualified custodian. These agreements would then propose restrictions and new requirements on custodians.
There are inherent challenges presented here, including negotiating arrangements with custodians and anticipating the fees that come with such arrangements. Those fees could be more substantial, and it will need to be determined whether the client or investor bears them.
Custodial Arrangements for Existing Markets
Since the proposal would apply to more than securities and funds while narrowing current arrangements and exceptions that RIAs rely on. A Safeguarding Rule could have a major impact on a variety of products and markets, including markets that are subject to CFTC regulation.
Should the proposal be adopted, it could lead to RIAs being forced to utilize custodial arrangements that are similar to what is required for registered investment companies per the Investment Company Act of 1940.
How Crypto Assets are Impacted
This is just the latest step by the SEC to aggressively regulate crypto assets. This proposal aims to treat crypto just like any other asset and it would be without exception. This proposal states that crypto assets wouldn’t be eligible for a privately offered securities exception. It also states that they are not physical assets eligible for exemption from the qualified custodian requirement.
As a result, RIAs with crypto assets would be required to custody those assets through the use of a qualified custodian. The SEC is currently engaged in ongoing litigation over when crypto assets fall under the definition of being a “security.” This proposal sidesteps that debate by simply subjecting all assets to the same obligations should an RIA be determined to require custody.
While explaining that a qualified custodian doesn’t require the need for exclusive control or possession of an asset. This is so long as it is required to go through a change of beneficial ownership. To execute a trade on a digital asset exchange, crypto and cash typically have to leave the control or possession of the qualified custodian. The QC must not be in possession in order to execute a trade, and the SEC warns against a platform that requires investors to pre-fund trades.
SEC Urging Participants to be Patient
Hester Peirce of the SEC acknowledged that enacting these changes will be a prolonged process. She assured that steady progress is being made by the SEC and that the regulatory body will work with industry participants to ensure that the transition is a smooth one.
Peirce also warned that compliance with these new rules will be pivotal. The SEC does implement its own enforcement procedures against individuals or companies that do break those regulatory compliance rules. Ongoing reforms should lead to significant changes in how the cryptocurrency market will be regulated in the future.
