TheCorporateCounsel.net

Earlier this week, Chairman Atkins, Commissioner Peirce, Commissioner Uyeda and Commissioner Crenshaw all addressed the Crypto Task Force Roundtable on Tokenization. Chairman Atkins analogized the movement of securities from off-chain to on-chain systems to the transition of audio recordings from vinyl to cassette to digital — noting that regulation needs to keep up with innovation.

Commissioner Crenshaw channelled Dr. Malcolm in her remarks and focused less on how the Commission could support the push toward tokenization and more on whether it should. While proponents argue that tokenization can facilitate a move to “T+0,” she says that may not be a good thing (and not just to avoid burnout of us lowly securities lawyers). Here’s an interesting snippet from her remarks — especially for folks looking to better understand the mechanics of our markets.

But the settlement cycle, while shorter than it used to be, is a design feature, not a bug. The intentional delay built in between trade execution and settlement provides for core market functionalities and protection mechanisms.

– For example, the settlement cycle facilitates netting. Roughly speaking, netting allows counterparties to settle a day’s worth of trades on a net basis rather than trade-by-trade. The sophisticated, multilateral netting that occurs in our national clearance and settlement system drastically reduces the volume of trades requiring final settlement. On average, 98% of trade obligations are eliminated through netting. This allows the current system to handle tremendous volume. It’s a key reason why our markets withstood sustained, record-breaking trade volume in recent weeks without major failures.

– Netting also facilitates liquidity. Because the vast majority of trades are “netted” and don’t require settlement, they don’t require an exchange of money. If A sells to B, B sells to C, and C sells to A, these trades are paired off and eliminated. A, B, and C can each retain their capital, as compared to a bilateral instant settlement over a blockchain, where each would have given up its cash for at least some period of time.

– Another important consideration is that instant settlement would generally disfavor retail investors, many of whom currently rely on the ability to submit payment after placing orders.

– We must also remember that critical compliance activities take place during the settlement cycle. These include checks designed to identify and prevent fraud and cybercrime. When red flags go up, the ability to pause a transaction and investigate is essential for investor protection and broader concerns like national security and counterterrorism.

For these and other reasons, it is not at all clear that shortening the existing settlement cycle is desirable or feasible. Regulators and major market participants, here and abroad, have persuasively argued otherwise.

Issues with same-day settlement have been debated before. The SEC sought comment on the path toward same-day settlement during the proposal phase of the shift to T+1, and Commissioner Peirce had laid out a few similar issues for specific comment, including whether the move would unnecessarily increase trading costs or affect market structure in ways that decrease liquidity.

– Meredith Ervine