The SEC Division of Trading and Markets issued a no-action letter providing time-limited (two-year) relief to allow a New York limited purpose trust company to use blockchain technology to settle equities securities trades.
According to the no-action letter, Paxos Trust Company, LLC ("Paxos"), a New York State Department of Financial Services regulated entity, is a participant in the Depository Trust Company ("DTC"), a securities clearing agency. Paxos sought permission from the SEC to act "as a clearing agency in connection with its operation of a securities settlement system" without registering pursuant to Section 17A of the Securities Exchange Act. The Paxos settlement service would be offered on a private, permissioned distributed ledger. Persons wishing to transfer securities or cash would deposit their securities or cash into Paxos' account at DTC and would receive a corresponding digitized entitlement on the Paxos ledger. (Accordingly, if counterparties to a trade were both Paxos participants, the relevant securities would just move onto the Paxos ledger, but would not move at DTC.)
Under the no-action letter, the service will be (i) in operation for a limited 24-month period (a/k/a the "Feasibility Study No-Action Phase") and (ii) confined within "well-defined" parameters that include a cap on the number of participants (seven) and on the number of securities trades (no more than 300 a day between each counterparty pair of the seven participants), and there will be further caps on the volume in any security that may be settled in a day.
The no-action relief will expire after the Feasibility Study No-Action Phase is complete. According to the Division, Paxos will:
wind down settlements by the 23rd month of operations;
settle "all outstanding obligations" of the service; and
ensure that participants withdraw all cash and securities from the service.
This is a significant no-action letter. It signals that the SEC is trying to get comfortable with the most important impediment to the use of blockchain in the financial markets: custody. By this letter, the SEC is testing whether Paxos can demonstrate that it can maintain good, auditable records of the positions that it maintains for each of the participants. If this can be done, there is the possibility for widespread use of blockchain in the securities markets and beyond. If Paxos shows that it can serve as an acceptable mechanism to transfer and custody securities, and the related cash, there is no reason it could not also serve to transfer and custody a wide variety of financial assets or to record a wide variety of transactions.
There are still many questions as to the operation of the system, including as to its speed and its ability to handle a heavy volume of transactions. But the letter demonstrates how far the commercial use of blockchain has moved from simply being a means to transfer assets anonymously between users to a payment method where all the parties to a transaction are known to a central authority.
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