SEC opens the door for discussion about crypto custody rules

March 19, 2019, | AtoZ MarketsAfter launching its information gathering campaign on March 12th, the United States Securities and Exchange Commission (SEC) is soliciting industry input, as it is reconsidering the existing custody labels with regard to particular cases of digital assets trading and settlement.

In the time being, it is the Custody Rule (Rule 206(4)-2) of the Investment Advisers Act of 1940 that determines the rules that aim to protect investors who delegate custody of their funds or securities to professional investment advisors.

As the letter the SEC sent to Karen Barr -president and CEO of the Investment Adviser Association- explains, such kind of custodial authority carries an ”increased risk of misappropriation or misuse of investors assets,” which means investment advisors are therefore legally bound to register with the SEC, and to comply with a series of rules for sound custodial practices.

The SEC says its appeal for input is pertinent to the application of the Custody Rule to digital assets, in particular as to whether any revisions to the rule are necessary “regarding the regulatory status of investment adviser and custodial trading practices that are not processed or settled on a delivery versus payment (“Non-DVP”) basis.”

The DVP settlement procedure and the risk involved

Practically speaking, a DVP settlement procedure is when a buyer’s payment for a given security is due at the same time as that security’s delivery.

In her coverage of the SEC initiative, Katherine Wu, the business development director of the research firm Messari, said that an example of DVP at work is the US DTC (Depository Trust Corporation) system. Here, the DTC clearing house acts as an SEC-registered custodian and intermediary that ensures both; the secure payment and transfer of securities between parties.

The settlement risk is regarded to be even higher, if the payment is made after delivering the security. This is called a non-DVP settlement procedure, which has not only the aforementioned example.

For the above mentioned, the SEC is now soliciting input on non-DVP settlement in the digital asset space, as for both the settlement process of peer-to-peer digital asset transactions, and the intermediated settlement that involves exchanges or over-the-counter trading platforms.

In its letter as well, the American financial watchdog sought information for points like what types of digital asset instruments trade on a non-DVP basis, how can custodians act in non-DVP digital asset trading, and the way they currently mitigate risks in.

Wu, who worked as a legal intern at the SEC prior to her crypto industry involvement, has given her perspective on the agency’s first move:

“What’s interesting to me is that the SEC does not seem to be jumping the gun in subjecting all non-DVP trades as under the custody rule, but rather is posing this as an opportunity for them to assess the underlying custody risks.” 

Exchange-traded funds are on the SEC table, as its chairman Clayton recently emphasized that custodial practices are a specific area of scrutiny, as the agency is reconsidering the regulation of new and prospective crypto investment instruments.

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