The American Bar Association’s Business Law Section recently issued a letter in response to a request for comments from the International Organization of Security Commissions (IOSCO) on its May 2019 Consultation Report addressing “Issues, Risks and Regulatory Considerations Relating to Crypto-Assets Trading Platforms” (IOSCO Report or Report).[1] The IOSCO Report, citing “the emergence of crypto-assets [as] an important area of interest for regulatory authorities,” provided guidance concerning oversight of secondary markets and the trading platforms that facilitate secondary trading of crypto-assets (Crypto-Asset Trading Platforms or CTPs). Members of the ABA Derivatives and Futures Committee’s Subcommittee on Innovative Digital Products and Processes (IDPPS) prepared the comment letter to highlight the need to evaluate whether new regulations are necessary to fit crypto-assets and CTPs within current regulatory frameworks, to consider the viability and potential of self-regulatory organizations (SROs), and to encourage an economic cost-benefit analysis of any new regulations.[2]
The IOSCO Report focuses on several major issues and considerations associated with regulating CTPs and provides helpful toolkits to assist regulatory authorities in analyzing these issues, with a goal of balancing regulatory oversight with fostering innovation. The IDPPS, with its comment letter, aims to provide helpful insight regarding striking the right balance.
The Report’s key considerations include: (1) access to CTPs; (2) safeguarding participant assets; (3) conflicts of interest; (4) CTP operations; (5) market integrity; (6) price discovery; (7) technology (systems resiliency, reliability, and integrity, as well as cybersecurity and resilience); and (8) custody, clearing, and settlement. The Report analyzes these issues with an eye toward promoting IOSCO’s core objectives regarding securities regulation, which include protecting investors and ensuring that the markets are fair, efficient, and transparent.
The Report also discusses certain of the currently operational CTP models, describes the risks and issues identified by regulatory authorities, and examines how such risks and issues have been, or could be, addressed. The IDPPS comment letter, in turn, encourages IOSCO and its members to consider what types of regulation are appropriate for CTPs, and poses the following questions:
- Would it be appropriate to regulate the CTP market through an SRO model, or would a mix of SRO with some form of regulatory oversight be appropriate? What types of considerations should local jurisdictions consider when structuring such a regulatory framework?
- Separately, would regulation by enforcement be sufficient, and what would be the key considerations in order to make such a determination?
As noted in the comment letter, the market is tackling not only the question of whether and what additional regulation is necessary, but also how to adapt existing regulations to cover these new risks in a regulatory framework that is not prohibitively expensive. Accordingly, SROs are an important means to balance these considerations, especially given the unique features of CTPs and the rapidly evolving crypto-asset markets. In particular, IOSCO, in its previously issued Model for Effective Self-Regulation, endorsed the use of SROs as having the potential to harness industry knowledge, respond quickly to marketplace changes, and potentially facilitate cross-border information sharing.
Crypto-assets, distributed ledger technology, and innovations in financial technology more broadly have the potential to significantly reshape the financial markets. The IDPPS agrees with IOSCO that “fostering innovation should be balanced with the appropriate level of regulatory oversight” and encourages IOSCO to continue engaging with industry participants, including technologists, to understand both the risks and the benefits of new technologies. As the Report recognizes, CTPs and crypto-asset trading generally will operate in ways not contemplated by existing financial regulatory frameworks. The comment letter encourages IOSCO to remain open to differing approaches to achieving regulatory objectives concerning crypto-assets and CTPs. With the rapid pace of technological advances, it also urges financial regulatory authorities to continue improving cost-benefit analyses to account for not only the direct impact of the rules being analyzed, but also the indirect burdens associated with a given rule and whether more flexible or less burdensome requirements can achieve the same or similar objectives.
The IDPPS was established in March 2018 and has over 80 members, comprised of attorneys who work extensively in the areas of derivatives and securities law, FinTech, and related areas. It is organized into three working groups: the Jurisdiction Working Group, the Blockchain Modality Working Group, and the SRO Working Group. In March 2019, IDPPS published a paper prepared by members of the Jurisdiction Working Group and their colleagues that provides a comprehensive survey of the regulation of cryptocurrencies and other digital assets at the federal and state levels in the United States, along with summaries of key initiatives outside the United States. IDPPS is undertaking other projects through its working groups as well. The Blockchain Modality Working Group is considering commercial and regulatory issues relating to application of blockchain technology in the financial markets and financial services industry, and the SRO Working Group is considering issues for potential implementation of self-regulation with respect to CTPs and digital assets markets.
[1] Special thanks to Paul Hastings Associate Andrew Sterritt for his assistance with this article.
[2] The IDPPS Subcommittee wishes to thank Yvette Valdes, Gavin Fearey, and Aaron Friedman for their contributions to the comment letter.