FINRA highlights risks, implications of DLT for securities industry

DLT for securities industry
DLT for securities industry

“DLT has the potential to affect various aspects of the securities market, including market efficiency, transparency, post-trade processes and operational risk”, FINRA notes in its report


The Financial Industry Regulatory Authority (FINRA) which regulates all securities firms doing business in the U.S. has published a detailed report on the implications of Distributed Ledger Technology (DLT), also known as Blockchain, for the securities industry.

The rationale for publishing this report is the growing interest and funding that this type of technology has attracted from the financial services industry over the recent years. According to a 2016 report by the World Economic Forum, which FINRA quotes, during the past three years more than $1.4 billion has been invested in DLT to explore and implement its uses in the financial services sector.

The regulator stresses that DLT may affect multiple aspects of the securities market, including market efficiency, transparency, post-trade processes and operational risk. Since DLT involves sharing of information with various entities over a network, it also implies security-related risks. Participants are advised to consider implementing enhanced security programs related to risks stemming from both internal and external sources.

FINRA also highlights a number if Implementation Considerations, such as governance, operational structure and network security.

Regulatory Considerations

FINRA lists a relatively big number of rules and laws to consider. Let’s focus on three of them.

  • Broker-Dealer Net Capital

Certain activities of a firm participating on a DLT network may have influence on the firm’s net capital requirements. If a broker-dealer holds cryptosecurities, digital currency or other cash-backed token holdings, then the firm has to consider how these would affect its net-capital computation under Exchange Act Rule 15c3-1, which “requires broker-dealers to maintain a minimum level of net capital (consisting of highly liquid assets) at all times.”

  • Anti-Money Laundering and Customer Identification Programs

Firms should consider various anti-money laundering (AML) and customer identification related regulatory obligations.

Let’s mention at least a couple of examples. The Bank Secrecy Act of 1970 (BSA) requires all broker-dealers to implement compliance programs to detect and prevent money laundering. In addition, under FINRA Rule 3310 (Anti-Money Laundering Compliance Program), broker-dealers should develop and maintain a written AML program to comply with the requirements of the BSA. The BSA also requires broker-dealers to have in place a customer identification program (CIP), which, amid other things, says that broker-dealers should verify identities of all parties with which they establish a formal relationship to effect securities transactions.

  • Customer Data Privacy

In a DLT network, certain customer data and transaction information may be shared by all parties on the network and may be vulnerable to exposure or access by undesired parties on the network. Regulation S-P requires from broker-dealers to have written policies and procedures in place to address the protection of customer information and records. Firms are also required to provide initial and annual privacy notices to customers describing information sharing policies and informing customers of their rights. In addition to that, SEC Regulation S-ID (the Red Flags Rule) makes it compulsory for broker-dealer firms that offer or maintain covered accounts to develop and implement written Identity Theft Prevention Programs. On top of that, certain states have specific rules and requirements related to customer data privacy.

The comment period expires on March 31, 2017.

Bitcoin and blockchain are most certainly to remain big themes in the fintech sector this year. Earlier this month, the New York State Department of Financial Services (DFS) issued a Bitlicense to Coinbase, the fifth virtual currency license awarded by the regulator.

As per London Stone Securities’ forecasts for 2017, it is important to consider the Indian influence and the development of Bitcoin and related technologies in China.

Russia’s position is key too, but while the Central Bank of Russia is exploring the potential applications of blockchain technology, it is strictly against Bitcoin, dubbing it as a means for financing terrorism and money laundering.

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