On September 8, The Nasdaq Stock Market LLC (Nasdaq) filed a Form 19b-4 with the Securities and Exchange Commission (SEC), proposing rule changes that would allow trading of equity securities and exchange-traded products (ETPs) in “tokenized form” on Nasdaq.
In its accompanying statement of purpose, Nasdaq proposed amending its definition of “Security” to allow trading of securities in the Nasdaq Market Center in either traditional form (without blockchain technology), or in “tokenized form” (utilizing blockchain technology). In either case, the security comprises “a digital representation of ownership and rights.”
What do the rules propose?
Under the proposed rules, tokenized securities could be traded on the Nasdaq Market Center, “together with, on the same Order Book as, and with the same execution priority” as identical securities in traditional form – provided the tokenized securities meet specific criteria. The tokenized security must:
- Be fungible with the traditional share
- Share the same Committee on Uniform Securities Identification Procedures (CUSIP) number, and
- Afford shareholders the same material rights and privileges as a share of an equivalent class of the traditional security.
If tokenized securities do not convey such rights or share the same CUSIP, the proposed rules would treat those instruments as distinct, such as derivative securities or American Depositary Receipts (ADRs).
Implications for market participants
Market participants wishing to clear and settle a security in tokenized form would note this preference by selecting a designated flag when entering their order in the national market system. Nasdaq would then communicate this to the Depository Trust Company (DTC), which would then execute the market participant’s order instruction in accordance with its rules, policies, and procedures.
Notably, the proposed rule changes and statement of purpose acknowledge that the requisite DTC infrastructure and post-trade settlement services are still under development. Regulatory approvals will be required, and DTC is currently working to develop such infrastructure, services, and procedures to facilitate the functionality.
Acknowledging that investors “increasingly demand the ability to own and trade tokenized versions of financial assets, including securities,” Nasdaq noted that it has been at the forefront of technological innovation in the securities trading markets, and that tokenization represents a new technology with “potential application” in the securities markets. Nasdaq’s filing and statement of purpose suggest that the proposed rule change is predicated on trading of tokenized equity securities occurring within the context of existing securities laws and rules, and by “leveraging existing structures and players and rules.”
Key takeaways
The proposed rule changes represent an attempt to accommodate the trading of tokenized securities utilizing blockchain technology within the framework of the existing national market system.
On one hand, Nasdaq’s proposal to use the blockchain to clear and settle trades of securities transcends any prior use of such technology by a national US securities exchange for this purpose, which to date has remained fairly limited. On the other hand, Nasdaq believes that “[t]oday’s system works extraordinarily well,” and does not propose allowing beneficial owners to take full custody of securities and trade them without SEC-registered intermediaries.
Nasdaq’s position on tokenization
Nasdaq states that trading “must occur in regulated markets, namely national securities exchanges, alternative trading systems, and at [Financial Industry Regulatory Authority] FINRA-regulated broker-dealers,” and that trading must also occur “within the context of an interconnected national market system, rather than in siloed trading venues where investors would have no consolidated sense of best market-wide prices and no assured access to such prices.”
Nasdaq warned that exemptions from these requirements could harm investors, potentially depriving them of access to portions of the markets if platforms were not required to connect to the national market system or report trades. Nasdaq asserts that this could erode the National Best Bid and Offer (NBBO), leaving markets, issuers, and investors with diminished transparency on those platforms and negatively impacting best execution protections.
Opportunities for comment and review
Following submission, both the SEC and the public will have an opportunity for comment and review. SEC Chair Paul S. Atkins recently expressed the SEC’s renewed focus on supporting innovation, capital formation, market efficiency, and investor protection. The SEC’s response to this letter may provide insights into its evolving approach to the adoption of blockchain technology in the securities markets.
Learn more
For more information, please contact the authors.