Yesterday Commissioner Hester Peirce said that the Securities and Exchange Commission (SEC) is inspired by some of the sandbox environments offered in other jurisdictions and is considering relaxing some registration requirements and rules to support tokenization and DLT based securities.

Historically the SEC has provided no action letters to individual entities. Commissioner Peirce said that the SEC is considering a “potential exemptive order that would allow firms to use DLT to issue, trade, and settle securities.” 

While regulators often talk about being technology agnostic, most legislation is based on technologies available when they were drafted. Compliance with existing regulations could cancel out some potential efficiencies enabled by new technologies such as DLT.

The Commissioner accurately described the chicken and egg situation where companies exploring tokenization might be unwilling to go through the expense of registering as a broker-dealer, exchange or clearing agency when the market for tokenized securities is pretty small. At the same time, the sector will remain small if issuers see a lack of secondary markets.

“It also would afford the SEC time to develop and adopt durable adaptations to its existing rules to accommodate DLT,” she said.

Sandboxes are commonly used in other jurisdictions with several launching ones dedicated to tokenization, including Europe (DLT Pilot Regime), Hong Kong (Project Ensemble), Singapore (Project Guardian) and the United Kingdom (Digital Securities Sandbox or DSS).

Tokenization volume limits and conditions

Of these initiatives, the DLT Pilot Regime has seen minimal adoption, in part because of strict activity limits. The UK’s DSS learned from that feedback and is planning entity-specific limits, so larger, more experienced entities are allowed higher volumes which can grow over time. Commissioner Peirce implied a similar thinking, with limits raised as the institution gets more experience.

She previously suggested a joint US-UK initiative with the DSS, which looks like it’s proceeding, but yesterday suggested collaborations with other jurisdictions.

Some sandboxes in other regions have been more focused on incumbents, such as Hong Kong’s and Singapore’s, whereas Commissioner Peirce hinted at encouraging startups by mentioning automated market makers.

Participation would not be condition free. It would include requirements around:

• market integrity compliance
• disclosures, including smart contract risks
• record keeping and reporting
• adequate financial resources
• custody transparency
• oversight by the SEC.

However, Commissioner Peirce’s speech discussed disclosures in other contexts, emphasizing the need to be principle based and focused on material issues, implying the SEC isn’t planning to use detailed checklists.

“The goal is to formulate a commercially feasible approach that protects investors, including by ensuring that they have the benefit of cutting-edge technologies for trading, clearing, and settling securities,” said Commissioner Peirce.

She’s likely to receive plenty of feedback next week at the SEC’s Tokenization Roundtable event.