There are many questions that must be answered to understand the risks for broker-dealers and investment advisors who are considering a business mix that includes digital assets. Examples that hit at the core of how firms operate are custody for investment advisors and a similar topic of possession and control for broker-dealers.
Unfortunately, for those of us in the United States, we continue to wait for clarity from the SEC. In the mean-time, many organizations are taking a conservative approach by avoiding these assets, or by implementing practices to mitigate the risk of an as-yet-unknown approach by regulators.
For RIAs, turning to the “modernized” custody information that predates the creation of digital assets is frustrating. The current rules require the use of a “qualified custodian” – which includes banks, savings associations, registered broker-dealers and futures commission merchants. While some traditional custodians are working towards a solution, the infrastructure to support this is limited at best within these types of organizations, which means your firm will need to make some tough choices. The SEC has defined alternative paths to establish internal controls when you don’t have a qualified custodian, but let’s face it, we are in new territory when it comes to the types of controls that lead you to a custody audit.
For broker-dealers, the approach to possession and control and the impact of treating them as non-allowable assets or as securities subject to potentially substantial haircuts for net capital purposes is one of the decision points that needs to be carefully evaluated.
At Oyster, we recommend a dialog with regulators as well as obtaining strategic and compliance guidance when you are considering entering the digital asset space. While there may not be answers, and the ones you get may not be the ones you like, it is important to get an understanding of the regulatory framework as it develops, specifics where they exist, guidance, and interpretation where they don’t. This will allow you to determine your risks, how to mitigate the risks you can and accept the risk that remains.
How Oyster Can Help
Oyster consultants have worked to create exchanges, ATSs, FinTech firms, and innovative financial products. We have worked with our clients to create new approaches to manage risk and compliance, client suitability, information security, data integrity, and trade, settlement, and counterparty controls.
Most importantly, our consultants have helped our clients to create businesses that succeed and to develop an approach that appropriately manages the risks associated with creating platforms that foster innovation, attract capital, and create trading and investment opportunities for investors and market participants.
