Despite the many challenges seen in 2020, innovation around tokenized securities continued. In what ways has the evolution of this market impacted the financial services industry? A panel of experts weighed in on that question during the DC (Washington) Bar Fintech Committee’s virtual event.
The event, which kicked off with a fireside chat, also featured a panel discussion including Valerie Szczepanik, Director, SEC Strategic Hub for Innovation and Financial Technology (FinHub); Michael Oh, Director, Office of Financial Innovation at FINRA; Jennifer Peve, DTCC Managing Director, Business Innovation; and Cathy Yoon, CJY Advisors Founder and Principal. Theresa Paraschac, DTCC Executive Director, Global Government Relations and Business Innovation, served as moderator for the panel discussion.
Robust and Resilient Innovation
As the market grapples with fast-moving technology trends, stakeholders are striving to understand how the industry will evolve. DTCC’s Peve kicked off the discussion with an overview of how the financial services industry has evolved to date regarding tokenization, stating, “various technologies implemented have allowed the industry to transform, as automation has let us do our jobs better and faster, improve and introduce new ways of working, and have thereby led to a better ecosystem.”
Will the next phase of innovation be led by digitization? Peve spoke of how a digital asset can be coded to include business rules and regulations and has the ability to retain those key references for its lifespan. With standardization, in addition to the ability for proactive compliance and risk management through the use of digital assets, benefits including minimized industry costs may be realized. Applying innovations, including the use of distributed ledger technology and tokenization, are ways to potentially help “future proof” the financial services industry. “Each evolution creates new business opportunities and innovation has the potential to also create seamless synchronicity and market efficiencies,” she noted.
Applying tokenization is not a one size fits all approach, and each case should be individually evaluated, Peve explained. For example, smart contract vulnerabilities need to be addressed, such as the exposure of the smart contract key and the potential for network disruptions. Peve added, “A modernized solution should not introduce new risks, and should be at least as robust and resilient as the existing application.”
Yoon provided insight into current legal considerations in the tokenization space, highlighting the information and guidance provided by regulators amidst the pandemic. “We’re on the brink of so much innovation,” she said. With regards to the recent SEC statement allowing broker-dealers to custody digital assets as stand-alone entities, Yoon stated she was looking forward to the comment period, and working with participants in the space to find the proper balance to ensure market integrity and consumer protection while still moving innovation forward in what she hopes will be in a technology-neutral manner.
“A modernized solution should not introduce new risks, and should be at least as robust and resilient as the existing application.” - Jen Peve
Responsibly implementing any new technology takes time to ensure market integrity. The recent elevation of FinHub to a standalone office at the SEC demonstrates the agency’s commitment to responsible innovation. The safety, security and soundness of markets is the offices’ primary goal and as Szczepanik added, “responsibly implementing new technology takes time. The agency is striving to gain more information, while finding a balance of market integrity and moving innovation forward.”
The panel discussion included a focus on the SEC’s recent statement regarding special purpose broker-dealer custody of digital asset securities, which, as explained by both the SEC and FINRA, is intended to encourage innovation and allow engagement with market participants.
According to Szczepanik, “We want broker-dealers to figure out how to custody digital assets in a compliant way. The tone of the statement is to promote innovation.” She added FinHub is looking forward to continuing to meet with innovators in the digital asset space and is exploring a range of innovation including, for example, in the decentralized finance space.
FINRA shared insight into the types of applications it has approved, and kinds of activity firms are proceeding with a growing interest in tokenized securities. As raised during the panel, there is a steady stream of interest in applications from firms to operate alternative trading systems (ATS) for digital asset securities or to perform private placements of digital assets. One example highlighted is the “Aspen Coin,” considered to be one of the first real estate digital security offerings, where shares of real estate were sold in a private offering and then tokenized on a public blockchain. Another is the recent approval of Oasis Pro ATS, which will allow subscribers to trade digital securities on the platform.
Additionally, during the past year, INX’s registration statement for its offering of security tokens was deemed effective. Also noteworthy is the ArCoin, which has a compliance feature embedded in its smart contract. “Enthusiasm is building over the potential for cost-efficient platforms as growing acceptance and maturity leads to less regulatory frictions,” said Oh.
Custody of digital assets will be one of the main focus points for regulators in 2021. In light of the recent SEC statement, FINRA will be looking at the complexities and best practices of having broker-dealers custody digital assets in a compliant way. Interest in the digital asset custody space is expected to come from existing or prospective ATS, as well as existing crypto custodians. As Oh stated, “we are keen to move forward and have the process move as expeditiously as possible, allowing broker-dealers to offer custody to digital assets in a smart, responsible way.”
2021 looks to be full of new developments in the tokenization space. Panelists predicted more activity in the private markets, as well as the issuance of new assets on DLT through tokenization and interest in ATS. There is also the potential for merger & acquisition activity as traditional financial firms look to expand into digital assets. Panelists also highlighted further initiatives and engagement with regulators, as the industry continues to move forward in a responsible, innovative way.