SEC Issues New Guidance on Issuer vs Third-Party Tokenized Securities

Highlights:

• The US SEC has released new guidance targeting different categories of tokenized securities.
• The move is targeted towards educating market participants on how these securities are treated under current rules. 
• The two broad categories of tokenized securities were those issued directly by the original company and those created by third parties

On January 28, the US Securities and Exchange Commission (SEC) released new guidelines on how securities laws apply to tokenized securities. The update comes from three divisions of the regulatory agency, including Corporation Finance, Investment Management, and Trading and Markets. 

The SEC’s latest move aims to help companies and other market participants understand how tokenized securities are treated under current rules. This is especially important now that more financial products are moving onto blockchain networks. For context, a tokenized security remains a normal security under US laws. It could be a stock, bond, or similar financial product. The only real difference will stem from formats.

In its official statement, the SEC divided tokenized securities into two broad categories. These include securities issued directly by the original company and securities created by third parties that are not connected to the original company. According to the regulatory agency, these two categories operate differently and carry different risks.

How Issuer-Tokenized Securities Work

In this case, the company that issued the security is responsible for creating the token, and the issuer must integrate blockchain into its ownership records. When the token moves on the crypto network, ownership automatically updates in the company’s official records. On-chain and off-chain data are used together. These include wallet addresses on one side and names and addresses on the other side.

Issuers must still register offers and sales unless an exemption applies. Meanwhile, companies are free to issue the same security in several formats. For example, some investors may hold traditional shares, while others hold tokenized versions. Investors can switch between these formats without breaching any rule.

If a company issues tokenized shares that have the same rights as its traditional shares, the SEC may treat them as the same class for legal purposes, depending on how similar the rights and features are. In a separate model, the token lacks legal rights. The real ownership record stays off-chain, as the token is only used to signal when a transfer occurs. 

Securities Issued by Third Parties Carry More Risks Under the New SEC Guidance

For these kinds of setups, the SEC noted that there could be so many variations. Some setups allow the token holder to own a direct interest in real security, while others provide no ownership rights and simply track price performance. According to the SEC, the main risk that could arise from any of these setups is the exposure to a third party’s failure or bankruptcy. 

For custodial tokenized securities, a third party holds the real security in custody. The token represents a claim or entitlement linked to that security. Whenever the token moves, records are automatically updated to show who is currently holding the entitlement. Overall, the token offers indirect exposure to the underlying security and not direct ownership.

Under synthetic tokenized securities, the third-party issues its own security that tracks the value or performance of another security. Products under this model are either linked securities or security-based swaps. Linked security tracks the value of another security but does not provide any rights in the original company. Meanwhile, security-based swaps provide exposure to a single security or certain events tied to a company.