SEC Extends Comment Period on Crypto Exchange Definition

The US Securities and Exchange Commission conducted a meeting last Friday to deliberate on the suggested elaboration of the meaning of an “exchange” to encompass decentralized cryptocurrency platforms.

Proposed Rule Change Expands SEC Oversight to DeFi Platforms

The commission emphasized that its existing regulations on exchanges apply to decentralized finance platforms, commonly referred to as DeFi platforms, which allow users to lend, borrow, and save digital assets without the need for conventional gatekeepers like banks and exchanges.

In January 2022, a proposal was introduced to broaden the definition of an exchange to encompass platforms utilizing “communication protocols” like request-for-quote systems.

The proposed modification is anticipated to broaden the scope of regulation beyond conventional exchanges where multiple buyers and sellers participate in a marketplace. It is aimed specifically at Treasury markets and other government security marketplaces where inter-dealer crypto brokers have been performing exchange-like functions without proper registration.

Despite being targeted at Treasury markets and marketplaces for government securities, the proposed rule change has received pushback from crypto firms who believe that it is vague and meant to subject DeFi platforms to SEC oversight.

SEC officials have noted that while some DeFi platforms may meet the proposed definition, others may already be considered exchanges under the current definition.

The SEC voted 3-2 during their meeting on Friday, to extend the public comment period for an additional 30 days. This will give the public more opportunity to comment on the proposed rule change. This move was unusual, as the commission usually decides privately on whether to extend the public comment period or not.

Republican Commissioner Hester Peirce criticized the SEC’s decision to reopen the comment period, arguing that the proposed rule change would promote centralization and undermine innovation. According to Peirce, the commission is unnecessarily expanding its regulatory reach to address non-existent issues.

Gary Gensler, the SEC Chair, contended that many crypto trading platforms already meet the existing definition of an exchange. He pointed out that irrespective of whether they refer to themselves as decentralized, most crypto trading platforms satisfy that definition.

The SEC’s move provided “very few answers” and likely raised additional questions for the sector, according to Nicholas Losurdo, a partner at Goodwin and previously counsel to former SEC Commissioner Elad Roisman.

The crypto industry has been urging the SEC to provide regulatory clarity, but Friday’s move suggests that the agency is still grappling with how to regulate the rapidly evolving sector.

SEC Reforms Mutual Funds At Investors’ Loss

Mutual funds have enabled a major chunk of the population to participate in the stock market for almost 100 years. And the US Securities and Exchange Commission (SEC) is after yet another asset class and has suggested modifications that may have adverse effects on these investment asset classes.

The SEC plans to require swing pricing for all mutual funds, which means that funds must adjust their daily share price, changing the net asset value whenever large redemptions cross a threshold determined by the SEC.

Unlike Europe, where swing pricing is optional, the SEC wants to force funds into a one-size-fits-all approach without considering the significant operational difficulties of implementing this policy.

As part of this proposal, the SEC wants to impose a “hard close” for orders at 4 pm Eastern Time, meaning that any orders that haven’t reached the fund by that time will not be accepted or priced until the next day.

This change is intended to enable funds to apply swing pricing based on flows. However, it will require brokers and retirement plans to impose earlier cut-off times for orders, which would deny investors full access to trading at today’s price during regular market hours.

While this may seem like an efficiency issue, it is actually a complete overhaul of the fund market’s infrastructure. If an order arrived at your broker (rather than the fund) a few hours before the cut-off, you would not receive today’s price. Instead, you would have to wait until the next day.

This would be confusing for the millions of Americans who use mutual funds to save for college or retirement, which amounts to 100 million people and would discriminate against Americans living in different time zones. The proposal’s unfairness has already drawn criticism from both sides of Congress.

The SEC’s reasoning behind the mandatory swing pricing is to address dilution, the idea that redeeming shareholders imposes costs on those remaining in the fund. However, this is the nature of the collective investment, and everyone enters and exits the fund at some point.

Additionally, the actual amount of daily dilution is negligible, averaging only fractions of tenths of a basis point, which is not large enough to encourage redemptions and is barely noticeable compared to the long-term returns investors receive from mutual funds.

The SEC’s proposal is believed to be aimed at satisfying central bankers who have long argued that open-ended funds are riskier than banks because of the “liquidity mismatch problem,” which makes them vulnerable to runs. Nonetheless, recent developments in the banking sector demonstrate that policymakers’ emphasis on open-ended funds was misguided.

Mandatory swing pricing is unlikely to change investor behavior during times of economic turmoil, such as a dash for cash due to financial uncertainty or a credit crisis. Instead, the SEC should prioritize making markets more resilient to the challenges that arise during such situations.

Insufficient data backs the proposal and it fails to evaluate the advantages and disadvantages to investors. Funds will have to bear substantial expenses as a result of the “hard close,” necessitating upgrades for all users such as custodians and transfer agents.

Furthermore, it needlessly risks disrupting the US capital markets as investors turn to other products.

This also poses an unwarranted threat of destabilizing the US capital markets by prompting investors to shift to alternative products.

It is paradoxical that while other parts of the world, such as the EU’s retail investment strategy, aim to foster sound participation of retail investors in capital markets, the SEC is pushing the US in a different direction.

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