SECP to regulate digital/virtual assets

ISLAMABAD: The Securities and Exchange Commission of Pakistan (SECP) has decided to regulate digital/virtual assets including security tokens.

The SECP Wednesday released a position paper on regulating digital assets. The paper outlines the concepts applicable for a nascent digital finance industry in Pakistan, examines regulatory frameworks in place in other jurisdictions and potential approaches to regulate digital assets in Pakistan.

This position paper focuses exclusively on Asset backed Security Tokens/Digital Assets and does not include any form of virtual/cryptocurrency or central bank digital currency.

One of the key advantages of digital assets is the ability to fractionalize each asset. Digital assets can be broken into more affordable and transferable units that create an opportunity for greater liquidity and investor diversity. Fractional ownership and trading of Digital Assets in secondary markets unlock liquidity in previously illiquid markets, creating entirely new tradable assets – such as real estate tokens – and enabling a more standardized form of trading for currently illiquid assets, such as corporate bonds.

Moreover, the barriers to issue an asset or security are significantly lowered opening up greater opportunity for smaller issuers while existing issuers benefit from new forms of securities.

The digital asset landscape has matured significantly and momentum is now being fueled by innovation in areas such as custody, settlement and post-trade – which remain critical functions in regulated financial markets.

The SECP will continue to engage with market participants and welcome industry feedback in deciding how to regulate the digital assets domain. This area has the potential to drive major improvements in efficiency and cost-reduction for the end-users by combining trading, settlement and custody services into one seamless service offering.

The SECP's objective of the regulatory framework is to support financial inclusion efforts and the advancement of technological innovation in a responsible and balanced manner; ensure the safety and efficiency of capital market and its institutions; ensure consumer and investor protection; minimise opportunities for regulatory arbitrage; combat the circumvention of exchange control rules and regulations; illicit financial flows, money laundering and the financing of terrorism.

According to the SECP, the digital assets also known as Virtual Assets, and Crypto Assets are the start of a new era of Digital Finance, and demand innovative regulatory measures and approaches by the regulators across the world. This could only be possible by initiation of a new era that re-invents regulatory regime/measures as they are known to the regulators globally today.

A global consensus has not yet emerged in relation to giving a unanimous definition to Digital Assets. This is because Digital assets have been treated differently by regulators across the World, some giving prime importance to operational perspective of digital assets while others have taken an approach to define them to be able to make the regulations robust to minimize Anti-Money Laundering, terrorist financing and tax evasion reservations for their respective jurisdictions. The problem is significant: even though the full scale of misuse of virtual currencies is unknown, its market value has been reported to exceed EUR 7 billion worldwide, the SECP said.

The SECP stated that there is a need to develop a policy and regulatory response to Digital Assets in Pakistan is driven by the following: i: Digital assets are a form of innovation that may impact the financial sector of the country: ii: Digital assets do not fit within the current regulatory framework; iii: Digital assets may create conditions for regulatory arbitrage while posing risks; and iv: Increasing interest, investment and participation in Digital Assets.

The SECP has also talked about the approaches available to regulate digital assets. First, can be regulating and restricting new products according to existing regulations, and may in some instances even entail outright banning. Under this approach, innovators are obliged to adapt to the prevailing regulatory environment. Second is based on the conjecture of ‘let-things-happen’ approach, described by the Commodity Futures Trading Commission (CFTC) as the ‘do-not-harm’ approach, where the financial sector is considered as dynamic and the associated need to innovate is strongly emphasised. The do-not-harm approach is highly cognizant of not letting overregulation stifle innovation, and supports finding the optimal balance between innovation, the concomitant risks and the wider safety of the financial system.

The SECP has also explained in detail two types of Digital Assets i.e. Utility Token and Security Token.

An option would be registering the Initial Exchange operators (IEO’s), who shall perform the due diligence to allow public offering through capital market by mode of issuing security tokens. Probable process can be an issuer to submit its application including a white paper to an IEO operator for approval.

The IEO operator will then assess the issuer and white paper and, if approved, facilitate the offering of the tokens to investors.

The SECP will be working with the IEO operator in assessing the IEO issuer. Once approved, the public may then invest in the issuer’s tokens from the IEO platform. This would require designing regulations to register Initial exchange operators (IEO’s) as well as prescribe a criterion to operate as such by the Commission. Resultantly, the IEO’s can only be offered by registered operators meeting the suitability criteria.

Another option would be to allow IEO’s for secondary trading as Decentralized Exchange Platforms (i.e performing the services of trading; settlement and custodian). The second option could be to separately register Digital Assets Trading (DAT) operators, DAT operator shall be providing the services of trading settlement and custodian services. Third Option could be allowing secondary trading through Pakistan Stock Exchange, and traditional mechanism of settlement and custody be followed, SECP added.

Copyright Business Recorder, 2020