House Committee Chairs Propose Digital Asset Framework for SEC and CFTC
Commentary by Steven Lofchie
House Financial Services Committee Chair Patrick McHenry (R-NC) and House Agriculture Committee Chair Glenn Thompson (R-PA) proposed legislation (the "Discussion Draft") that would establish a digital asset framework and provide for related joint rulemaking from the CFTC and the SEC. (See also, section by section summary, provided by the Committees.)
The bill would provide that (i) digital commodity exchanges, digital commodity brokers and digital commodity dealers would be permitted to register with the CFTC and (ii) broker-dealers and alternative trading systems would be permitted to register with the SEC. Issuers of digital assets would be required to comply with a new disclosure regime based on the "nature of the risks" surrounding the digital assets. The Discussion Draft also provided an exemption from securities laws for digital asset issuers whose sales meet specific conditions. Further, the SEC and the CFTC would have the authority over transactions involving stablecoins with an SEC or CFTC registered entity, respectively. However, the Discussion Draft does not give the SEC or the CFTC authority over the "design, structure, or operation" of payment stablecoins.
Additional provisions:
- Registration with the SEC. Under the proposed legislation, "digital commodities" and "payment stablecoins" would be excluded from the definition of a security under security laws. The SEC would also be required to (i) modernize recordkeeping requirements regarding the use of distributed ledger technologies and (ii) modify, as necessary, its rules to account for digital assets. In particular, the SEC would be required to amend its custody rules to provide that a broker-dealer has control of a digital asset if the digital asset is held in a bank.
- Registration with the CFTC. The CFTC would have "exclusive regulatory jurisdiction" over transactions involving digital commodity cash or spot markets and digital commodity exchanges or digital commodity broker-dealers. The legislators also included requirements that (i) digital commodity exchanges comply with "core principles," such as listing standards, treatment of customer assets and trade surveillance, (ii) qualified digital asset custodians must be eligible to hold digital assets for customers of CFTC registered entities and (iii) digital commodity broker-dealers follow, among other requirements, business conduct standards, fair dealings, customer disclosures, segregation of customer funds and conflicts of interest.
- Innovation and Technology. The proposed legislation would establish the "Joint CFTC-SEC Advisory Committee on Digital Assets" which would make regulatory recommendations to the CFTC and the SEC. Separately, the SEC and the CFTC would each be required to conduct respective studies on decentralized finance ("DeFi") which would cover (i) an examination of potential DeFi protocols and (ii) the risks and benefits of using DeFi. The legislators also included a section that would require the U.S. Department of Commerce to work with the White House Office of Science and Technology, the CFTC and the SEC to conduct a study on non-fungible digital assets.
Statements
Chair Thompson called the proposed legislation a "historic joint effort"; [i.e., a joint effort between the Financial Services Committee that oversees the SEC and the Agriculture Committee that oversees the CFTC, as opposed to a Republican/Democrat joint effort] that aims to "close existing authority gaps between the CFTC and SEC and bolster U.S. leadership in financial and technological innovation." Chair McHenry stated: "Our goal is to strike the appropriate balance between consumer protection and encouraging responsible innovation. This is the product of an unprecedented joint effort between the House Financial Services and Agriculture Committees, which gives us a better shot at striking that balance. I encourage stakeholders and market participants to provide constructive feedback to help us improve our legislation."
Commentary
The Discussion Draft is by far the most in-the-weeds legislative proposal that has been put forward to date. There are a number of "big picture" items that stand out:
- The Discussion Draft produced by the Committee Chairs calls for specific revisions to existing SEC Rules, most significantly the Custody Rule. That should force the SEC to consider what amendments to its rules are required to make them work for digital assets, as opposed to merely repeating that digital assets must comply with the existing rule set, which are in many respects a poor fit for digital assets.
- The Discussion Draft would actually provide the CFTC with substantially more jurisdiction than previous legislative proposals where the grant of additional jurisdiction was largely limited to cash market trades in Bitcoin and Ether.
- It is a shame, which arguably worked to the material detriment of investors (see FTX,) that the SEC has simply refused to put forward even the start of a regulatory scheme that works for digital assets (leaving aside the efforts of Commissioner Peirce, with which the Commission majority has declined to engage). The more thoughtful comments that the Representatives receive as to the Discussion Draft, the more difficult it will be for the SEC to simply do nothing and hope the product goes away.