The US agency has used a no-action letter to enable a sandbox-like approach to blockchain-based trade settlements.
By Stephen P. Wink, Cameron R. Kates, Shaun Musuka, and Deric Behar
In what may be the first regulator-approved application of blockchain technology for the settlement of US equities trades, the Division of Trading and Markets of the US Securities and Exchange Commission (SEC) recently granted no-action relief to Paxos Trust Company (Paxos) to conduct a two-year “feasibility study” of a securities settlement service using distributed ledger technology. During this period, Paxos will be permitted to operate as a clearing agency under Section 3(a)(23) of the Securities Exchange Act without needing to register as a clearing agency under Section 17A(b)(1) of the Act. The no-action relief for the Paxos Settlement Service (PSS) is limited to clearing a volume-restricted number of trades per day of highly liquid publicly traded equities, for at most seven eligible broker-dealers.
The PSS is a private and permissioned blockchain-based platform that is expected to enable counterparties to “conduct simultaneous delivery versus payment settlement of securities and cash.” To do so, PSS users seeking to trade securities for cash will deposit them into PSS’s Depositary Trust Company (DTC) account, while PSS users seeking to exchange cash for securities will deposit US dollars into a Paxos bank account. Following receipt, Paxos will mint digital representations of the securities and cash known as “digitized security entitlements” and deposit them into the respective PSS accounts of the users. Once a trade settlement date is set and both parties have provided sign-off, the PSS will automatically settle the obligations on the settlement date by simultaneously transferring the digitized security entitlements between the two users’ PSS accounts. Paxos believes the PSS will offer faster clearing times along with greater cost efficiency, data accuracy, and security, compared with legacy systems. While PSS could one day emerge to rival intermediary clearinghouses, such as the DTC, it will rely heavily on DTC’s infrastructure at least during the two-year feasibility study.
In a sense, the no-action relief is a bespoke regulatory sandbox for Paxos, a well-known blockchain technology provider that is also the proprietor of the Paxos Standard dollar-backed stablecoin and PAX Gold gold-backed token. During the two-year period, Paxos will be able to offer settlement services on a chaperoned pilot-program scale without fear of regulatory enforcement (provided that Paxos abides by the well-defined parameters of the no-action request and letter, including operating transparently, with strong governance and controls, and with effective safeguards to prevent market disruption).
In the wake of the no-action relief, Paxos announced that it would begin to settle certain large-cap US equities transactions for select broker-dealers, and that it is equipped to scale the blockchain settlement technology at a later time to accommodate other asset classes and geographies. The SEC for its part will be able to monitor the benefits and risks of the new technology in a real-world setting, in advance of any significant scaling. The no-action relief is a promising sign that the SEC is evaluating the role and adoption of blockchain-based settlement by the securities industry and is open to new ways of implementing this technology.
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