The Israel Securities Authority’s (ISA) commission for examining the regulation necessary for the advancement of digital markets recently published its conclusions. The commission’s conclusions are meant to serve as a tool for realizing the goal of assimilating technological innovation into the Israeli capital market. The commission’s report focuses on platforms for the issuing, trading, and clearing of securities that make use of blockchain technology (distributed ledger technology), inter alia, through tokens and smart contracts.
The primary findings and recommendations included in the report are as follows:
Blockchain Technology and Its Potential
Most of the initiatives focus on the clearing and settlement phase, since blockchain technology has the potential to reduce financial risk, as well as significantly shorten the time between performance of the transaction and its clearing, to the point of the clearing being accomplished almost in real time. Therefore, the use of this technology by stock exchanges and clearing houses may enable them to propose in the future new and advanced services. Indeed, traditional financial institutions, including stock exchanges and clearing houses, as well as new players, are promoting initiatives and conducting experiments to incorporate or replace blockchain technology as the core of their business.
The use of digital securities, issued on the basis of blockchain technology, raises complex and innovative issues, such as possession and custody, data and cyber security, money laundering and terror financing, the finality of the clearing, and the transparency of data and trading information, both during the ex-trade and the post-trade stages. Naturally, a time will come when the ISA will be required to consider these issues, and will need to learn from the experience of regulators around the world.
The Use of DLT Technology for the Purposes of Clearing Securities
The ability of blockchain technology to verify and update information accessible to many parties simultaneously may provide it a clear advantage for the purposes of clearing securities. There are a number of theoretical advantages attributed to this technology, including the increased efficiency and resilience of existing clearing processes and an increased ability to implement automation.
As a result, use of this technology may significantly shorten the time between performance of the transaction and its clearing, thus reducing credit risks, market risks, and counter party risks, as well as reducing the guarantees clearing houses and end users are required to provide for trading purposes.
Currently, the regulation of clearing houses’ operations under the Israeli Securities Law is primarily skeletal, therefore it allows relative flexibility in shaping the regulation to fit the characteristics of clearing houses based on blockchain technology.
Regulating the Trading Platform
While in the United States and Europe there is a hierarchy of regulation for trading platforms based on certain characteristics, in Israel, there is only singular regulation for a multilateral trade platform such as a stock exchange.
The United States has regulation that applies to “national stock exchanges,” such as the NASDAQ and the NYSE, which are required to meet the strict demands and supervision of the Securities and Exchange Commission (SEC), alongside regulation that covers alternative trading systems (ATS), which operate under a broker-dealer license that operates the ATS.
Europe has two different types of regulation that apply to multilateral trading platforms. The first addresses the “regulated market” and is the equivalent term in the MiFID II Directive to the US national stock exchange. The second addresses a multilateral trading facility (MTF), which is the equivalent term to the American ATS.
The ISA notes that some of the regulatory duties imposed on a stock exchange may hinder the establishment of a relatively small trading platform, since the rules were designed with a view to a significant national stock exchange operating through its exchange members.
The Supply Aspect – A Disclosure and Reporting Regime
The ISA believes the profiles of the investing public and the companies traded on a digital exchange should not significantly differ from a non-digital exchange. Therefore, a different reporting standard should not be applied to a digital exchange compared to that currently applied to reporting corporations, except for a number of specific adjustments.
Money Laundering and Technological Risks
The ISA emphasizes the need to meet the obligation on the prohibition of money laundering as a vital and necessary condition. In addition, alongside the many advantages technology presents, it has quite a few risks that should be properly addressed.
In addition to the commission’s report, the ISA has published an open call inviting companies to raise regulatory issues concerning the development of markets using new technologies and the possible existing barriers.