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The Securities and Exchange Commission ("SEC") has issued a no-action letter to the Depository Trust Company ("DTC") in connection with the registered clearing agency's pilot blockchain-based securities tokenization program. A no-action letter is a document issued by the SEC in response to a request from an individual or entity seeking confirmation that their planned activities do not constitute a violation of federal securities laws. The DTC's program enables the tokenization of entitlements to certain eligible securities held by investors through the DTC. Investors opting into the program are able to utilize pre-approved blockchains and registered wallets to hold their tokenized securities entitlements and transfer them among other program participants. The plan also permits "de-tokenization" whereby the tokenized entitlement is reverted to a standard book entry with the DTC. The SEC's blessing for the plan represents a significant step towards moving markets "on-chain."
The DTC sought no-action relief under three specific sets of provisions of the federal securities laws: (1) Regulation Systems Compliance and Integrity, (2) Section 19(b) of the Securities Exchange Act of 1934 (the "Exchange Act") and Rule 19b-4 thereunder, and (3) Exchange Act Rules 17Ad-22(e) and 17Ad-24(i) and (j). Collectively, these rules concern the activities of clearing agencies and other entities and address technological infrastructure, risk management, governance, and operational requirements. In seeking no-action relief, the DTC had to detail how its plan achieves compliance with each of these rules.
According to the DTC's plan, a participant registers with the DTC on an approved blockchain and obtains a registered wallet to hold tokens corresponding to securities entitlements. The participant then instructs the DTC to tokenize their securities. The DTC then debits securities from the participant's account, credits a centralized ledger, and mints and delivers a token reflecting the participant's securities entitlements to the user's registered wallet. The participant could then transfer the token to other registered wallets without instructing the DTC. This transfer is recorded on the underlying blockchain. Next, the DTC deploys off-chain software to scan the blockchain and track the movement of tokens, storing the data in what would constitute the DTC's official books and records. Participants could also "de-tokenize" their entitlement representation by burning the token and reverting to a standard DTC book entry.
The DTC stated that the program will allow participants to leverage the benefits of blockchain and tokenization, including mobility (i.e., the ability to transfer assets across jurisdictions and time zones without regard to standard trading hours or holidays), decentralization (i.e., the ability to access assets more directly), and programmability (i.e., the ability to use smart contracts to optimize transfers or allocations of assets), without forgoing the protection and accountability that a central securities depository and registered clearing agency such as DTC provides.
The SEC's no-action letter highlighted a number of representations by the DTC regarding recordkeeping, security eligibility, strategy to resolve system issues, periodic reporting packages, technological transparency, disclosures, and satisfaction of technological requirements. In light of these representations, the SEC concluded that it would not recommend enforcement action under the aforementioned regulations. However, the SEC noted that its letter would be "withdrawn without further action three years from the date DTC launches operation of the Preliminary Base Version of the DTCC Tokenization Services," putting a definitive shelf-life on the relief. This restriction appears to account for the program's pilot nature. If it proves successful, more lasting relief may be granted by the SEC.
No-action letters, including this one, send important signals to the market. The DTC's grant of no-action relief may open the door for other fintech actors and encourage them to seek similar assurances. By automating recordkeeping and disintermediating the transfer process, the DTC's pilot program, if successful, stands to serve as an important model in modernizing the securities markets. The SEC's implicit nod for the tokenization of securities opens a path for moving markets on-chain while maintaining certain traditional investor protections.
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