2020 brought many changes to the world, including an acceleration in the pace of asset digitization—a space that is bringing about many exciting yet unexplored issues.
I spoke with Valerie Szczepanik, Director, Strategic Hub for Innovation and Financial Technology (FinHub), Securities and Exchange Commission (SEC) to discuss how the agency is engaging with market participants, as well as developments the agency provided this year, particularly in regard to tokenized securities.
As the head of FinHub, Szczepanik leads the office that coordinates and consolidates the fintech-related work across the SEC. FinHub helps the agency work with market participants and regulators worldwide while encouraging leading-edge innovation. The office brings the expertise within the commission back into FinHub, creating an exciting cross-pollination of new and existing knowledge.
She stated, “we lend expertise across the commission. Internally that includes rulemaking, policy work and enforcement work. At the same time, [FinHub] serves as a platform for public engagement with developers, entrepreneurs, lawyers and academia, all in an attempt to foster responsible opportunities for innovation.”
FinHub was created in 2018, and in December, was elevated to a stand-alone office at the SEC. “This reorganization is a commitment to foster responsible innovation, provides more dedicated resources and gives FinHub a more prominent, permanent stature as we explore new and evolving technologies,” Szczepanik said.
With an eye on developing technologies, FinHub is currently focused on distributed ledger technology, blockchain, digital assets, Artificial Intelligence, Machine Learning, robo-advising (automated investment advice) and online marketplace lending.
Despite a challenging year, the SEC made significant developments in 2020. Szczepanik spoke about new offerings in the digital asset space and how the agency takes a technology-neutral approach. “Regardless of if a security is traditional or digital, or what technology is used in issuing or trading, we are still applying the same rules and regulations.”
“Regardless of if a security is traditional or digital, or what technology is used in issuing or trading, we are still applying the same rules and regulations.” - Valerie Szczepanik
The Commission has been evaluating custody of the digital asset space and engaging with the industry on the various concerns. These conversations led to the groundwork for the digital asset custody statement, whereby the agency is looking to encourage innovation and feedback by taking a unique no-action position for five years. Due to the change in administration, the statement has not yet been published in the federal register.
Special purpose broker/dealers will be allowed to custody digital asset securities, pursuant to the Customer Protection Rule 15(c)(3) [17 CFR 240.15c3-3]. “We’re looking for engagement with market participants as they innovate in this area. We encourage input so we can evaluate and see if our approach needs to be modified.” Szczepanik is hopeful that the five-year period will encourage participants to innovate and enhance their ability to afford customer protections around the possession and control of digital assets.
Looking ahead to 2021, I asked Szczepanik about some of FinHub's priorities. Given the forced transition to a telework environment, Szczepanik remarked how the agency is looking at how regulators can continue to perform supervisory roles in the changing environment. This includes the use of innovative technology for regulators and supervisors to implement and enforce regulations and aims to assist in digital communication between market participants and regulatory organizations, or supervisory technology or “SupTech.”
FinHub has been looking at the impact of global stablecoins, following the recommendations made by the Financial Stability Board (FSB) in October. The agency is also working to understand the various structures of decentralized finance (“DeFi”) and figuring out what risks they bring to the financial markets. These applications and structures built on top of blockchain are designed to provide the same services and functionalities as traditional financial services products and systems.
Szczepanik also touched on how coordination between other government regulatory agencies and FinHub is crucial. The sibling agencies—the Commodity Futures Trading Commission (CFTC), the Office of the Comptroller of the Currency (OCC) and the Financial Crimes Enforcement Network (FinCEN)—are all facing similar challenges working with emerging technologies. Sometimes the jurisdictions overlap, and Szczepanik said, “communication is key as we have different jurisdictions and mandates. It is important that we take a coordinated approach as each agency applies their own rules and regulations.”
Issues such as anti-money laundering and countering the finance of terrorism apply internationally to digital as well as traditional assets. As broker/ dealers begin to get involved in the developing digital asset markets, Szczepanik noted that it is important to recognize that obligations under the Bank Secrecy Act apply.
The financial industry and regulators are continuing to engage on the topic of tokenized securities, promoting innovation in a responsible way.