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The U.S. Securities and Exchange Commission is always one to mince words.
While millions of investors are pumped to start playing cryptocurrency, the SEC just threw two Wall Street trade groups for a loop. They were angling to be able to sell cryptocurrency ETFs and mutual funds to the public before they received a staff letter from the director of the SEC's Division of Investment Management asking how sponsors of crypto ETFs or mutual funds could safeguard public investors.
This is the real meat of the cryptocurrency discussion. If crypto is going to blossom and bloom into a game anyone can play, then the powers that be need to know that this ring toss isn't a trap for the average Joe. As the letter states, "many of America's Main Street investors rely on registered funds to help them build toward education, retirement, and other important goals."
Of course, that doesn't mean that the SEC spelled it out for the ETF-selling hopefuls. Instead, it did what it always will – couch the hard-hitting questions in jargon and complicated reference material.
If you are a longtime reader, you'll know that this is my "Bat-Signal"; breaking down gated information for anyone to be able to digest is my favorite pastime.
Here's your study guide to the SEC's crypto pop quiz..
Section I: Fund-amentals
- "How would funds develop and implement policies and procedures to value, and in many cases 'fair value,' cryptocurrency-related products?"
- "How would funds consider the impact of market information and any potential manipulation in the underlying cryptocurrency markets on the determination of the settlement price of cryptocurrency futures?"
The two reference materials you'll need for this unit are a Nov. 14, 2017, reference article by Business Insider author Oscar Williams-Grut titled, "Market Manipulation 101': 'Wolf of Wall Street' – Style 'Pump and Dump' Scams Plague Cryptocurrency Markets," and a Dec. 10, 2017, Fortune article by David Z. Morris titled, "Could Bitcoin's 'Whales' Manipulate the Market?"
Essentially, the cryptocurrency gold rush has created an elite few who now have a power that, because this is unregulated territory, they can abuse. The SEC wants to know how the creators of ETFs would be able to honestly price their funds when pump-and-dump ICOs are a reality of the crypto landscape.
- "What steps would funds investing in cryptocurrencies or cryptocurrency-related products take to assure that they would have sufficiently liquid assets to meet redemptions daily?"
- "How would a fund prepare for the possibility that funds investing in cryptocurrency-related futures could grow to represent a substantial portion of the cryptocurrency-related futures markets? How would such a development impact the fund's portfolio management and liquidity analysis?"
To answer these questions, you might want to bone-up on the new fund liquidity rule, rule 22e-4, and the 459-page "Final Rule on Investment Company Liquidity Risk Management Programs," Release Nos. 33-10233; IC-32315; File No. S7-16-15.
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It's not as scary as it seems. These are questions that would be asked of any new fund, just with a modern tech twist. As long as these Wall Street trade groups make sure that their liquidity practices fall under this new rule, they're in the clear.
- "To the extent a fund plans to hold cryptocurrency directly, how would it satisfy the custody requirements of the 1940 Act and relevant rules?"
- "To what extent would cybersecurity threats or the potential for hacks on digital wallets impact the safekeeping of fund assets under the 1940 Act?"
There is no hint for this one. The Investment Company Act of 1940 was designed to wrangle the Wild West of mutual funds that were previously unregulated and open for exploitation. In this portion of the quiz, the SEC is doing their due diligence by asking how these new crypto funds will meet the parameters of this Act. Will there be the proper disclosure of conflicts of interest, the necessary oversight?
If the nitty-gritty of how to domesticate untamed crypto tech isn't nailed down, there will be no fund. Plain and simple.
Section II: Risky Business
About the Author
Shah Gilani boasts a financial pedigree unlike any other. He ran his first hedge fund in 1982 from his seat on the floor of the Chicago Board of Options Exchange. When options on the Standard & Poor's 100 began trading on March 11, 1983, Shah worked in "the pit" as a market maker.
He helped develop what has become known as the Volatility Index (VIX) - to this day one of the most widely used indicators worldwide. After leaving Chicago to run the futures and options division of the British banking giant Lloyd's TSB, Shah moved up to Roosevelt & Cross Inc., an old-line New York boutique firm. There he originated and ran a packaged fixed-income trading desk, and established that company's "listed" and OTC trading desks.
Shah founded a second hedge fund in 1999, which he ran until 2003.
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