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Distributed Ledger Technology: Implications of Blockchain for the Securities Industry


This paper provides an overview of distributed ledger technology, highlights some key applications being explored in the securities industry and potential impact of the technology, and discusses key implementation and regulatory considerations for broker-dealers.






FINRA welcomes an open dialogue with market participants to help proactively identify and address any potential risks or hurdles in order to tap into the full potential of DLT, while maintaining the core principles of investor protection and market integrity. Technological innovations in the industry, operating in accordance with these core principles, have the potential to provide investors with greater access to services and enhanced experiences, offer firms increased operational efficiencies and enhanced risk management, and enable further transparency in the marketplace.

This paper is intended to be an initial contribution to an ongoing dialogue with market participants about the use of DLT in the securities industry. Accordingly, FINRA is requesting comments from all interested parties regarding all of the areas covered by this paper. FINRA also requests comments on any related matters for which it would be appropriate to consider additional guidance, consistent with the principles of investor protection and market integrity, based on DLT applications and their implications for FINRA rules.

INTRODUCTION:

Distributed Ledger Technology (DLT) (also known as blockchain technology or distributed database technology) has attracted significant interest and funding in the financial services industry in recent years. Several large financial institutions have established dedicated teams to explore the technology, and some market participants have formed consortia to create industry standards. According to a 2016 report by the World Economic Forum, over the past three years more than $1.4 billion has been invested in this technology to explore and implement uses in the financial services industry.

There are varying views in the securities industry on the magnitude of disruption DLT may cause. Some have argued that DLT has the potential to revolutionize the operations of the securities industry, while others have debated that any changes resulting from the use of DLT in the securities industry are likely to be incremental and take many years to develop.

However, most agree that the technology has the potential to bring additional efficiencies and increased transparency to the industry while also presenting some novel risks such as those related to data security and privacy. Some analysts and research reports predict that we may start seeing adoption of the technology in limited market segments in a matter of months, with larger-scale industrywide adoption potentially occurring after several years. Over the past couple of years, FINRA has actively engaged with various industry participants, including financial institutions, vendors and professional services firms, to monitor developments related to DLT and its potential impact in the securities industry. In particular, FINRA spoke to several FINRA member firms to better understand their current or potential future use of DLT. These broker-dealers highlighted their perspective on the potential benefits and challenges posed by DLT, and noted that they are considering how different DLT applications would operate within the current regulatory framework.

Many FINRA rules as well as some rules implemented by other regulators (such as the Securities and Exchange Commission (SEC)), that FINRA is responsible for examining or enforcing with respect to broker-dealers, are potentially implicated by various DLT applications. For example, a DLT application that seeks to alter clearing arrangements or serve as a source of recordkeeping by broker-dealers may implicate FINRA’s rules related to carrying agreements and books and records requirements. The use of DLT may also have implications for trade and order reporting requirements to the extent it seeks to alter the equity or debt trading process.5 Moreover, as more fully discussed later in this paper, other FINRA rules such as those related to financial condition, verification of assets, anti-money laundering, know-your-customer, supervision and surveillance, fees and commissions, payment to unregistered persons, customer confirmations, materiality impact on business operations, and business continuity plans also may to be impacted depending on the nature of the DLT application.

As the securities industry continues to explore and adopt DLT, many market participants have indicated the impending changes are more than just those associated with the automation of a process or adoption of a new technology system, but instead represent the potential to create a paradigm shift for several traditional processes in the securities industry through the development of new business models and new practices. As a result, there has been a great desire among industry participants to have increased regulatory engagement, as they explore the technology and its possible applications.

FINRA welcomes an open dialogue with market participants to help proactively identify and address any potential risks or hurdles in order to tap into the full potential of DLT, while maintaining the core principles of investor protection and market integrity. Technological innovations in the industry, operating in accordance with these core principles, have the potential to provide investors with greater access to services and enhanced experiences, offer firms increased operational efficiencies and enhanced risk management, and enable further transparency in the marketplace.

This paper is intended to be an initial contribution to an ongoing dialogue with market participants about the use of DLT in the securities industry. Accordingly, FINRA is requesting comments from all interested parties regarding all of the areas covered by this paper. FINRA also requests comments on any related matters for which it would be appropriate to consider additional guidance, consistent with the principles of investor protection and market integrity, based on DLT applications and their implications for FINRA rules.

In the sections that follow, FINRA provides a basic overview of DLT, highlights some key applications being explored in the securities industry and potential impact of the technology, and discusses key implementation and regulatory considerations for broker-dealers.

View full report:
http://www.finra.org/industry/report-distributed-ledger-technology-implications-blockchain-securities-industry

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Thursday, February 2nd 2017
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