On October 28, 2019, the Securities and Exchange Commission (“SEC”) granted Paxos Trust Company, LLC (“Paxos”) a request (the “Request”) for no-action relief (the “Paxos No-Action Letter”) in connection with Paxos’ operation of a securities settlement system that uses distributed ledger (i.e. blockchain-based) record-keeping to reflect ownership and changes in ownership of participant positions (the “Paxos Settlement Service”).1 It will be the first private and permissioned distributed ledger system to act as a settlement service for U.S. equities.
The Paxos Settlement Service conducts trade-by-trade simultaneous delivery versus payment settlement of securities and cash for trades submitted to the Paxos Settlement Service for settlement, and provides same day settlement between the Participants. Though the range of services is initially limited, it tests the potential of blockchain for security settlements and may lead to fully-functional blockchain-based clearing and settlement systems. Of note, while the Paxos No-Action Letter represents limited SEC approval of distributed ledger record-keeping, it does not envision maintenance of a duplicate conventional record in parallel with the distributed ledger record.2
Paxos is a New York limited purpose trust company that is regulated by the New York State Department of Financial Services and is a participant of the Depository Trust Company (“DTC”). Under the Paxos No-Action Letter, Paxos will not have to register with the SEC as a clearing agency pursuant to Section 17A(b)(1) of the Securities Exchange Act of 1934 (the “Exchange Act”) while operating the Paxos Settlement Service for a twenty-four month trial period (the “Feasibility Study No-Action Phase”). While not expressly defined as a “Regulatory Sandbox,” the parameters and limited duration of the Feasibility Study No-Action Phase appear to reflect the SEC’s willingness to experiment with the potential utility of blockchain in connection with record-keeping and processing for securities transactions.
The Paxos No-Action Letter affords Paxos the opportunity to test the benefits of the Paxos Settlement Service in a live production environment during the Feasibility Study No-Action Phase. The Feasibility Study No-Action Phase will be conducted in a “de minimis” manner with parameters and limits on the volume of shares settled through the Paxos Settlement Service.3
Paxos believes that the Paxos Settlement Service’s same day delivery versus payment process will significantly reduce record-keeping costs and decrease the time by which participants can access securities and trade proceeds. Paxos has announced that Credit Suisse and Société Générale have agreed to become early adopter participants in the Paxos Settlement Service.
The Paxos No-Action Letter does not address all the potentially relevant issues involving the Paxos Settlement Service, including whether the Paxos record-keeping regime has received any necessary bank regulatory approvals, whether Paxos is a bank under Section 3(a)(6) of the Exchange Act, and whether securities left at Paxos by its participants are under the “control” of the participants for purposes of the SEC’s Rule 15c3-3.
Seward & Kissel will continue to monitor future developments in this area. If you have any questions regarding the Paxos No-Action Letter or any other blockchain-related matters, please contact your S&K contact attorney or any member of S&K’s Blockchain and Cryptocurrency Group.
1 The Request and the Staff’s Response are available at https://www.sec.gov/divisions/marketreg/mr-noaction/2019/paxos-trust-company-102819-17a.pdf.
2 For a different approach that involves keeping both a distributed ledger record and a parallel conventional record, see our client alert “Asset Manager Makes Preliminary Filing for a ‘Blockchain Enabled’ Money Market Fund, and SEC Approves Registration of First-Ever Blockchain-Based Transfer Agent.”
3 The operations of the Paxos Settlement Service during the Feasibility No-Action Phase are subject to the following:
- a limit of seven participants who satisfy criteria for participation will be eligible to use Paxos Settlement Service;
- a requirement that settling securities be publicly traded equity securities registered pursuant to Section 6 of the Securities Act of 1933, as amended, and Section 12 of the Exchange Act;
- requirements that eligible securities must be traded between potential counterparty pairs on approved trading venues and not have an average daily volume of more than 300 trades executed between any potential counterparty pair; and
- requirements that daily targets for the per security share volume submitted to the Paxos Settlement Service (1) be less than 100,000 shares per security, per counterparty pair, and (2) across all counterparty pairs, aggregate less than 1% of the total average daily trading volume of the security.
Paxos will establish and maintain procedures that are reasonably designed to ensure compliance with the above parameters. The Staff will closely monitor the Paxos Settlement Service through prior and same day notifications of certain events, quarterly and ad hoc reports, and documented findings related to the Feasibility Study No-Action Phase.