Modernizing is always the best practice

3,476,141 non-professionals were monthly subscribers to data for NYSE-listed securities in the fourth quarter of 2019. These users generally are retail investors, obtaining data by requesting quotes from their brokers.

National Best Bid and Offer (NBBO) is a regulation by the United States Securities and Exchange Commission that requires brokers to execute customer trades at the best available (lowest) ask price when buying securities, and the best available (highest) bid price when selling securities, as governed by Regulation NMS.

On physics, there are unavoidable limitations due to the speed of light—and the speed of fiber optic cable.  This means that, as long as users are not all in the exact same location—which they are not—information cannot reach all users at exactly the same time.  As a result, the NBBO at one location will vary slightly from the NBBO at another location.

Today, hundreds of firms are located in different locations.  Some buy NMS market data, some aggregate proprietary data.  Some get their data over fiber.  Some get their data over microwave towers.  Anyhow, you get the point. There is no one NBBO in a world where markets are quoting and trading in nanoseconds.

According to Director Brett Redfearn, today, the best-priced offer for a higher-priced stock in NMS market data may be 100 shares for $400.50, while the exchange proprietary data feeds may have a 20-share offer at $400.45.  If a retail investor places a 20-share buy order and it is executed at $400.48, the executing venue is entitled to report that the retail investor received two cents for price improvement.  This is true even though an odd-lot quote on the exchange proprietary data feeds was readily available at a price that was three cents better than the “price-improved” execution supposedly provided to the retail investor.

The SEC have hard work ahead, plenty of responsibilities, and they are doing it for us, in order to keep our funds safe. The future for sure will be different and modernize. Maybe, blockchain technology can assist, once it will become faster, only god knows. Hopefully, we get better prices in the future.

Is trading history simply information about an economic transaction with no expressive value or maybe it is time for more smart contracts?

Some people might say, “Of course it’s different: trading history is not protected expression; it is simply information about an economic transaction with no expressive value.” However, economic transactions offer a window into a person’s deepest thoughts and core values. Our purchases and sales of securities, particularly when aggregated together, are a rich form of value expression. They might express a view of how markets work, a determination on the efficiency of markets, expectations about the future, or even a moral philosophy. Investors’ trades may flow from a carefully crafted trading strategy based on a person’s education, careful data analysis, intuition, or market experience. People may trade to express their belief about how a company, industry, or nation will perform in the short- or long-term. People might sell stock because they fear a recession is coming or buy stock because they anticipate that the election of a particular candidate or party will bring a period of economic prosperity. An investor might buy shares of a movie company because she is sure a particular movie will be popular, shares of a technology company because he/she believes the company’s engineers are geniuses, or the shares of a cellphone provider because he/she believes a strategic merger is on the horizon.

According to SEC commissioner, Hester M. Peirce’s statement, we should not risk our freedom and privacy. If history is any guide, unauthorized access to, or disclosure of, the information contained in the Consolidated Audit Trail (CAT) is almost certainly just a matter of time.

Given these risks, the commissioner advise to eliminate the CAT, and if the Commission believes the program needs further improvement, it could enhance the current rules. The current regime provides the information needed, and incremental improvements to reduce delays and errors could make the commission investigations more efficient without sacrificing Americans’ liberty and privacy.

What if people will use smart contracts to buy shares and other securities? How will the SEC follow them? Does the SEC wants us to use smart contracts to get more privacy?

Understanding the money laundering needs via informal/formal stakeholders public speeches

It was interesting to read the following speech of Therese Chambers, Director of Retail and Regulatory Investigations.

Crypto businesses may want to consider the following when proving services via a UK entity:

Under the MLRs, any firm undertaking one of the specified cryptoasset activities is required to satisfy the FCA when they arrive at our authorisations team that they have:

Risk assessment: to identify where the risks of money laundering lies in their business and establish policies and procedures to tackle them.

Customer Due Diligence (CDD): as there is a zero threshold for all activity in this sector, all transactions, whether occasional or part of an ongoing business relationship, will need to be subject to CDD. This means identifying the customer and verifying their identity on the basis of reliable and independent documentation or information. As cryptoasset activities are online, then they will need to establish the veracity of the information provided to ensure the person on the other side of the screen is who they claim to be. We expect that many will apply similar approaches to e-money and challenger banks who often deploy new technologies such as video/photo identification via mobile.

Transaction monitoring: cryptoasset firms will need to monitor the transactions that they execute on behalf of their customers to identify any potential suspicious or unusual transactions that indicate a risk of money laundering. While we know of several services that offer blockchain analytics software which can help with this task, we will still require that firms have the right processes in place to evaluate transactions. This is because all FCA regulation is underpinned by the notion that you can outsource work but not responsibility.

Record keeping: the MLRs require all firms to retain documents and information used as part of CDD and transaction monitoring for a period of 5 years after the end of a business relationship, but they do not need to be kept for longer than 10 years since the start of that relationship.

Suspicious Activity Report (SAR) reporting: where a firm identifies suspicious activity that they have reasonable ground to suspect is the proceeds of crime then they need to make a SAR and send it to the National Crime Agency (NCA).

When a firm arrives at the FCA’s gateway looking to apply for registration, we believe that a ‘good’ application will clearly demonstrate to our authorisations team that they have robust systems and controls to cover each of these areas. But fundamentally, we are looking for more than just whether the firm has the right policies and procedures, we need to be satisfied that the firm take seriously their responsibilities to prevent their business being used to launder the proceeds of crime.

The FCA’s crypotasset AML regime is still in its infancy, as it only came into effect on the 10 January 2020. We are expecting several key challenges. First, this is largely a market that is new to regulation, and since the premise of the technology comes from a libertarian strand of ideology which eschews identity checks and advocates digital privacy, so we are expecting compliance with AML regulation will be met with resistance. But we are keen to work with the industry to ensure our AML standards are met in this market, particularly since this sector is closely integrated with traditional financial services.

 

The Custody challenges of digital asset securities

According to the U.S. SEC market participants wishing to custody digital asset securities may find it challenging to comply with the broker-dealer financial responsibility rules without putting in place significant technological enhancements and solutions unique to digital asset securities. 

A broker-dealer seeking to custody digital asset securities must comply with the Customer Protection Rule. If the broker-dealer fails, customer securities and cash should be readily available to be returned to customers.

There are many significant differences in the mechanics and risks associated with custodying traditional securities and digital asset securities. For instance, the manner in which digital asset securities are issued, held, and transferred may create greater risk that a broker-dealer maintaining custody of them could be victimized by fraud or theft, could lose a “private key” necessary to transfer a client’s digital asset securities, or could transfer a client’s digital asset securities to an unknown or unintended address without meaningful recourse to invalidate fraudulent transactions, recover or replace lost property, or correct errors. Consequently, a broker-dealer must consider how it can, in conformance with the law, hold in possession or control digital asset securities.

If, for example, the broker-dealer holds a private key, it may be able to transfer such securities reflected on the blockchain or distributed ledger. However, the fact that a broker-dealer (or its third party custodian) maintains the private key may not be sufficient evidence by itself that the broker-dealer has exclusive control of the digital asset security (e.g., it may not be able to demonstrate that no other party has a copy of the private key and could transfer the digital asset security without the broker-dealer’s consent). The above mentioned risks could cause securities customers to suffer losses, with corresponding liabilities for the broker-dealer, imperiling the firm, its customers, and other creditors.

It should be noted that the broker-dealer’s difficulties in evidencing the existence of these digital asset securities may in turn create challenges for the broker-dealer’s independent auditor seeking to obtain sufficient appropriate audit evidence.

The Crypto asset market (digital asset) or the law may need to continue devolving and/or amending in order to achieve an understanding.

 

Regulators are here to prompt innovation

FCA, for instance, is placing a limit on investments in P2P (peer-to-peer) agreements for retail customers new to the sector of 10 per cent of invest-able assets. This is an important means of ensuring that retail customers do not over-expose themselves to risk. The investment restriction will not apply to new retail customers who have received regulated financial advice.

In addition, P2P platforms should have the following:

  • More explicit requirements to clarify what governance arrangements, systems and controls platforms need to have in place to support the outcomes they advertise, with a particular focus on credit risk assessment, risk management and fair valuation practices.
  • Strengthening rules on plans for the wind-down of P2P platforms if they fail.
  • Introducing a requirement that platforms assess investors’ knowledge and experience of P2P investments where no advice has been given to them.
  • Setting out the minimum information that P2P platforms need to provide to investors.
  • Applying the Mortgage and Home Finance Conduct of Business sourcebook and other Handbook requirements to P2P platforms that offer home finance products, where at least one of the investors is not an authorised home finance provider.

On the other side of the ocean, the SEC’s Strategic Hub for Innovation and Financial Technology, plays an important role in facilitating the SEC’s active engagement with innovators, developers, and entrepreneurs.

As part of a continuing effort to assist those seeking to comply with the U.S. federal securities laws, FinHub published a framework for analyzing whether a digital asset is a security. The framework is not intended to be an exhaustive overview of the law; rather, it is a tool to help market participants assess whether the federal securities laws apply to the offer, sale, or resale of a particular digital asset. Additionally, the Division of Corporation Finance issued no-action response to a market participant in connection with the proposed offer and sale of a digital asset.

In case your intentions are good, regulators are open for business. Moreover, a productive government is a great deal.