The SEC has recently raised regulatory concerns about cryptocurrencies, including valuation, custody and volatility.
The regulator's Division of Investment Management asked sponsors to refrain from initiating registrations for funds investing in cryptocurrencies and related products. Dalia Blass, the division director, cited “significant outstanding questions” about how such funds could comply with applicable laws and regulations.
Despite these concerns, I believe that regulators and the industry will work through these issues and develop rules and best practices that will ensure the growth of this market in a manner that engenders investor confidence.
Here are the top 10 alarms raised by the SEC:
1. Valuation: The SEC asks whether funds could obtain sufficient information to properly value fund assets pursuant to current accounting rules especially given the “nascent state and current trading volume” in the futures markets.
2. Liquidity: Could funds reduce crypto-assets to cash so as to meet daily redemption requests? How would funds classify assets under the SEC’s new liquidity rule (22e-4)?
3. Custody: The SEC questions how a fund custodian could validate the existence and ownership of cryptocurrency assets, and how funds would address physical security where applicable.
4. ETF creation: Will the creation unit process operate in a way that ensures that funds and authorized participants limit arbitrage opportunities that harm investors?
5. Volatility: The limited history and volume of the cryptocurrency markets could negatively impact fund operations and affect investors.
6. Lack of regulation: Neither cryptocurrency markets, nor providers and issuers are subject to prudential regulation.
7. Market manipulation: The SEC cites Chairman Clayton’s concerns over market manipulation and potential fraud.
8. Cybersecurity: Could a potential hack threaten ownership interests and valuation? What safeguards are in place?
9. Disclosure: How would fund sponsors ensure sufficient risk disclosure and transparency in fund prospectuses and other shareholder communications?
10. Suitability: How will broker-dealers and advisors ensure their suitability and fiduciary obligations when recommending crypto-funds to retail investors?