Sharing with #CryptoPH BlockDevs Asia’s Comments on the proposed SEC Regulatory Sandbox where we proposed for new sections on Petition for Rulemaking and Token Safe Harbor exemption (adopted from US SEC Commissioner Peirce’s proposal).
Hoping we can rally the community to support our proposals. It’s not yet late to let the SEC know that you endorse BlockDevs’ proposal (email them at email@example.com).
Your +1 on our proposals will help persuade the SEC to seriously consider having a token safe harbor exemption in the Philippines.
The letter is as follow:
12 October 2023
PhiliFintech Innovation Office
Securities and Exchange Commission (SEC)
7907 Makati Avenue, Salcedo Village
Barangay Bel-Air, Makati City 1209
Attention: Atty. Paolo Montano M. Ong, Securities Counsel II
Re: Comments on Draft SEC Regulatory Sandbox Framework
Dear Atty. Paolo,
BlockDevs Asia Inc. (“BDA”), a non-stock corporation founded in 2019, is a volunteer-driven nonprofit association of blockchain developers in the Philippines and Asia Pacific that is dedicated to promote the interest of its members and encourage the growth of blockchain and crypto-based ecosystems.
On behalf of BDA, we submit this Comment, including some proposed changes, on the proposed draft SEC Regulatory Sandbox Framework (“SEC RSF”).
Comprehensive list of eligible activities (Sec. 3)
We propose the following minor change in Section 3 of the Draft SEC RSF:
Section 3. Specific Activities Allowed in the Sandbox – To provide clarity to potential Sandbox Participants and the public, the SEC shall periodically post and maintain on its website a comprehensive but non-exclusive list of eligible activities and innovations that are allowed to enter and operate within the regulatory sandbox.
xxx xxx xxx
The purpose of the proposed change is to make it explicit that the comprehensive list of eligible activities that may be published by the SEC is only designed as a guidance, but it should not be interpreted as a closed list of eligible innovations. It would be extremely impractical and unrealistic to come up with a complete list of sandbox-eligible activities considering that any ground-breaking innovation is conceptually unforeseeable.
Financial technologies develop rapidly and therefore today’s “comprehensive” list may no longer be exhaustive tomorrow or next month. It would not be a good policy to disqualify a potential participant from lodging an application simply because an innovative product or activity was inadvertently omitted from the latest SEC list.
Sandbox process (Sec. 6)
We propose the following change in Section 6 of the Draft SEC RSF:
Section 6. Sandbox Process – A regulatory sandbox will include the following stages:
xxx xxx xxx
xxx xxx xxx
An application may be rejected if it fails to meet the objective and principles of the sandbox or any of the evaluation criteria: Provided, that the SEC shall give the applicant a reasonable time to modify the objectionable portions of the application before rejecting the application. After its application has been rejected, the applicant may reapply for the sandbox when it is ready to meet the objective, principles, and evaluation criteria of the sandbox.
xxx xxx xxx
This proposed amendment is intended to provide a sandbox applicant an opportunity to amend or update a particular portion of its submissions and address any initial objections or concerns that the SEC may have in relation to the regulatory sandbox application. Due to the novelty and highly technical nature of this application, it would be more productive and efficient to allow the applicant some leeway to make the necessary changes instead of re-filing a new application with the SEC.
Lastly, we noticed that the Sandbox Application Form (SAF) referenced as Annex 1 in Section 7 of the Draft SEC RSF has not yet been included in the draft published by the SEC on 28 September 2023 for public comments. Considering that the Sandbox Application Form will be an integral part of the sandbox rules and an important document that should be considered by any prospective applicant, we highly recommend that the SAF be included in the subsequent releases of the Draft SEC RSF.
Minimum requirements; fund segregation requirement (Sec. 8)
We propose to amend Section 8 of the draft SEC RSF to remove the requirement that the funds must be deposited in a bank registered with the Bangko Sentral ng Pilipinas (BSP) for purposes of segregation:
Section 8. Minimum Requirements – The applicant for a sandbox must incorporate the following safeguards in their proposed testing plan:
xxx xxx xxx
4. Separation of sandbox participant funds and customer funds deposited;
in a bank registered with the Bangko Sentral ng Pilipinas;
xxx xxx xxx
Developments in financial technology in the last 15 years—particularly cryptocurrencies, blockchain and decentralized finance (DeFi)—have shown that taking custody of customer funds is no longer absolutely necessary in conducting a financial transaction. While we do not question the soundness of the policy of requiring fund segregation, we firmly believe that it would be counterproductive to innovation if the SEC would strictly require funds to be deposited in a traditional financial institution, such as a commercial bank.
While a sandbox participant may freely deposit customer funds in a commercial bank to ensure proper segregation, this should not be imposed as a requirement. To do so will disqualify a significant number of use cases and projects that employ alternative custodial approaches or arrangements in delivering financial services, such as by depositing cryptoassets to: (a) a licensed virtual asset service provider (VASP); or (b) to a non-custodial (i.e., self-custodied or “unhosted”) wallet controlled solely by the customer; or (c) to a multisignature (multisig) wallet where the customer controls one of the multiple required private keys; or (d) to a decentralized escrow powered by a smart contract; or (e) or through atomic swap.
Our hypothesis is that technology could substitute and even improve certain aspects of financial services, such as custody. One does not need to personally subscribe to this hypothesis in order to grasp the significance of decentralized technologies. It is sufficient that a rapidly growing number of people are actively using them for various economic and financial transactions in the Philippines and abroad. If this much is true, then decentralized technologies serve a public good.
Our hypothesis should be tested and examined through experimentation in the sandbox. This would not be possible if at the onset, participants will be strictly required to employ traditional financial institutions to take custody of customer funds. Rather than imposing the proposed minimum requirement, how customer funds are segregated and secured by the participant should instead be assessed by the SEC during the evaluation phase—exercising ring-side oversight and providing recommendations as may be needed, subject to rigorous stress-test during the experimentation stage. Custody risk cannot be absolutely eliminated, but the point of sandbox is to study and learn how to effectively manage such risk as well as develop risk-mitigation solutions within a controlled environment, in accordance with the SEC-approved Testing Plan.
Petition for rulemaking (Sec. 14)
We propose to amend Section 14 of the draft SEC RSF to introduce an additional clause that would authorize sandbox participants to file a petition for rulemaking (PRM), thus:
Section 14. Transition to Public Offering; Petition for Rulemaking – Sandbox Participants that graduated from the regulatory sandbox may formally submit to the SEC an application for the required license to offer the financial product or service to the public at large, with the endorsement of the Sandbox Committee through the completion certificate, subject to the issuance of special rules allowing the registration of the said activity. Sandbox Participants are hereby authorized to propose or petition for the issuance, amendment, or repeal of a rule or regulation promulgated by the SEC to implement the relevant provisions of the SRC, Revised Corporation Code (R.A. No. 11232), Investment Company Act (R.A. No. 2629), Lending Company Regulation Act (R.A. No.9474), Financing Company Act (R.A. No. 8556), Financial Products and Services Consumer Protection Act (R.A. No. 11765), and other laws administered by the SEC. Such Petition for Rulemaking (PRM) shall attach the proposed new rules, amendment or deletion, provide explanatory notes on the legal basis and policy considerations of the proposal, and include the source or citation if the proposed rule is adopted from a foreign jurisdiction, international organization, or another regulatory agency. The SEC shall endorse the proposed new rules to the appropriate department or office for review, comments and recommendations. Within fifteen (15) days from receipt, the SEC shall publish the PRM, along with the proposed new rules and explanatory notes, for public comments. The SEC shall allow the public to comment on the PRM within a period of not less than fifteen (15) days from publication. The SEC shall act on the PRM and may adopt the proposed new rules subject to amendments after taking into account the comments of the appropriate departments or office and the public.
The proposed amendment above is designed to enable the SEC to benefit from the outcomes of the regulatory sandbox program, employing the lessons learned to discover how existing rules and regulations of the SEC may be improved and enriched. Our proposed amendment also aligns with the BSP’s regulatory sandbox framework that allows participants to submit recommendations on policy issuances or proposed rule amendments to address risks arising from the innovative financial solution. This policy recognizes the advantages of crafting bespoke rules that are custom-fit for new delivery channels for financial services, addressing the problem of “square peg in round hole” when it comes to financial regulation.
By taking initiative to file a petition for rulemaking, sandbox participants can help the SEC formulate bespoke regulation to address peculiar risks associated with financial technology, especially technology and cybersecurity risks. For example, the rapid technological advances in machine learning, deep learning and artificial neural networks now enable investment algorithms to scan massive data sets which could produce investment decisions that may be incomprehensible to human mind. What happens when an investment advisory firm and its employees cannot explain the investment advice and decisions to financial consumers? What security assurances do a roboadvisory platform have and how can they be overseen by the SEC according to existing rules? Should there be new rules that will require the platforms, applications, algorithms and the methodologies of roboadvisors to undergo independent vulnerability assessment and third-party penetration testing?
Moreover, we emphasized in the proposed amended Section 14 that the PRM may involve a proposed change in the existing rules and regulations implementing the Revised Corporation Code (R.A. No. 11232), Investment Company Act (R.A. No. 2629), Lending Company Regulation Act (R.A. No.9474), Financing Company Act (R.A. No. 8556), and Financial Products and Services Consumer Protection Act (R.A. No. 11765), or any other law administered by the SEC. We foresee the possibility that the lessons learned from the sandbox might inspire, if not require, a change or an update on the administrative rules and other issuances concerning the Revised Corporation Code with respect to possible uses cases of blockchain and smart contracts as corporate governance solution for remote shareholder voting or election; Lending Company Regulation Act for crypto lending, use of cryptoassets as collateral and flash loans; Financing Company Act with respect to deep-tier financing and other types of supply chain financing; Investment Company Act with respect to roboadvisors, crypto hedge funds and crypto-derivatives (whether exchange-traded or over-the-counter); and Financial Products and Services Consumer Protection Act with respect to crypto-focused financial advisers.
Digital asset safe harbor (new provision)
We propose a new section (which may be numbered as Section 15 or 16) to provide a safe harbor exemptive relief for issuers of digital assets, which the SEC is authorized to grant under Section 72.1 of the SRC.
Section 16. Digital Asset Safe Harbor –
(a) Conditions. Pursuant to Section 72.1 of the SRC, the offer, sale, or transaction involving a Digital Asset shall be exempt from registration if the following conditions are satisfied by the Initial Development Team, as defined herein:
- The Initial Development Team intends for the relevant network, protocol or decentralized application on which the Digital Asset functions to reach Network Maturity within the duration of the regulatory sandbox;
- Disclosures required under paragraph (b) of this section must be made available on a freely accessible public website;
- The Digital Asset must be offered and sold for the purpose of facilitating access to, participation on, or the development of the network;
- The Initial Development Team files a Notice of Reliance in accordance with paragraph (c) of this section; and
- An Exit Report is filed in accordance with paragraph (f) of this section.
(b) Disclosure. The Initial Development Team must provide the information described below on a freely accessible public website:
1. Initial Disclosures. Prior to filing a Notice of Reliance on the safe harbor, provide the following information (any material changes to the information required below must be provided on the same freely accessible public website as soon as practicable after the change):
- Source Code. A text listing of commands to be compiled or assembled into an executable computer program used by network participants to access the network, amend the code, and confirm transactions;
- Transaction History. A narrative description of the steps necessary to independently access, search, and verify the transaction history of the network;
- Cryptoeconomics. A narrative description of the purpose of the network, the protocol, economic incentives, and its operation. At a minimum, such disclosures must include the following: (1) information explaining the launch and supply process, including the number of Digital Assets to be issued in an initial allocation, the total number of Digital Assets to be created, the release schedule for the Digital Assets, and the total number of Digital Assets outstanding; (2) information detailing the method of generating or mining Digital Assets, the process for burning Digital Assets, the process for validating transactions, and the consensus mechanism; (3) explanation of governance mechanisms for implementing changes to the protocol; (4) sufficient information for a third party to create a tool for verifying the transaction history of the Digital Asset (e.g., blockchain or distributed ledger); and (5) hyperlink to a block explorer;
- Development Roadmap. The current state and timeline for the development of the relevant network, protocol or decentralized application to show how and when the Initial Development Team intends to achieve Network Maturity.
- Prior Digital Asset Sales. The date of sale, number of Digital Assets sold prior to filing a Notice of Reliance on the safe harbor, any limitations or restrictions on the transferability of Digital Assets sold, and the type and amount of consideration received.
- Initial Development Team and Certain Digital Asset Holders. Furnish the following information: (1) names and relevant experience, qualifications, attributes, and skills of each person who is a member of the Initial Development Team; (2) number of Digital Assets or rights to Digital Assets owned by each member of the Initial Development Team and a description of any limitations or restrictions on the transferability of Digital Assets held by such persons; and (c) if any member of the Initial Development Team or Related Person has a right to obtain Digital Assets in the future, in a manner that is distinct from how any third party could obtain Digital Assets, identify such person and describe how such Digital Assets may be obtained;
- Trading Platforms. Identify secondary trading platforms on which the Digital Asset trades, to the extent known;
- Sales of Digital Assets by Initial Development Team. Each time a member of the Initial Development Team sells at least five percent (5%) of his or her Digital Assets over any period of time, state the date(s) of the sale, the number of Digital Assets sold, and the identity of the seller;
- Related Person Transactions. A description of any material transaction, or any proposed material transaction, in which the Initial Development Team is a participant and in which any Related Person had or will have a direct or indirect material interest. The description should identify the nature of the transaction, the Related Person, the basis on which the person is a Related Person, and the approximate value of the amount involved in the transaction.
- Warning to Digital Asset Buyers. A statement that the purchase of Digital Assets involves a high degree of risk and the potential loss of money.
2. Semi-annual Disclosures. Every six (6) months following the date of filing the Notice of Reliance, pursuant to paragraph (c) of this section, until the end of the sandbox duration or until Network Maturity has been reached, whichever occurs first, provide updated information as of the end of the six-month period, which must be submitted within thirty (30) days after the end of the relevant semi-annual period.
(c) Filing of Notice of Reliance. The Initial Development Team must file with the SEC a Notice of Reliance on the safe harbor prior to the date of the first Digital Asset sold in reliance on the safe harbor. The Notice of Reliance must contain the following information:
- The name of each individual on the Initial Development Team;
- Attestation by a person duly authorized by the Initial Development Team that the conditions of this section are satisfied;
- The website where disclosure required under paragraph (b) may be accessed; and
- Email address at which the Initial Development Team can be contacted.
(d) Duration of Exemption. The exemptive relief provided by this section will expire at the end of the duration of the regulatory sandbox, including any approved extension thereof.
(e) Exit Report. An Exit Report must be filed with the SEC not later than sixty (60) days from the end of the duration of the regulatory sandbox, including any approved extension thereof. The exit report must contain, at the minimum, the following information:
1. If Network Maturity has been reached for a decentralized network, protocol or decentralized application, an analysis by outside counsel must be provided. The analysis should include: (a) a description of the extent to which decentralization has been reached across a number of dimensions, including voting power, development efforts, and network participation. If applicable, the description should include: (1) examples of material engagement on network development and governance matters by parties unaffiliated with the Initial Development Team; (2) explanations of quantitative measurements of decentralization; (b) explanation of how the Initial Development Team’s pre-Network Maturity activities are distinguishable from their ongoing involvement with the network. The explanation should: (1) discuss the extent to which the Initial Development Team’s continuing activities are more limited in nature and cannot reasonably be expected uniquely to drive an increase in the value of the Digital Assets; (2) confirm that the Initial Development Team has no material information about the network that is not publicly available; and (3) describe the steps taken to communicate to the network the nature and scope of the Initial Development Team’s continuing activities.
(ii) If Network Maturity has been reached for a functional network, protocol or decentralized application, an analysis by external counsel must be provided. The analysis should: (a) Describe the holders’ use of Digital Assets for the transmission and storage of value on the network, the participation in an application running on the network, or otherwise in a manner consistent with the utility of the network; (b) detail how the Initial Development Team’s marketing efforts have been, and will be, focused on the Digital Asset’s consumptive use, and not on speculative activity; (c) if the Initial Development Team determines that Network Maturity has not been reached and no other party has filed an exit report, the following information must be provided: (1) status of the project and the next steps the Initial Development Team intends to take; (2) contact information for Digital Asset holders to communicate with the Initial Development Team; and (c) statement whether the Initial Development team will file a Registration Statement under Section 8 of the SRC which, if affirmative, must be filed within 120 days from the filing of the exit report.
(f) Transition Period for Virtual Asset Service Providers and Trading Platforms. No virtual asset service provider (VASP) or trading platform shall be subject to the registration requirements of SRC, whether as an Exchange, Broker, Dealer, Clearing Agency or any other securities intermediary, due to activity related to the listing or trading of Digital Assets for the duration of the sandbox and for sixty (60) days thereafter (“Transition Period”); Provided that, the VASP or trading platform shall review and determine the legal status of the Digital Asset, particularly whether the same constitutes a security, prior to listing or trading the Digital Asset beyond the Transition Period.
(g) Digital Assets Previously Sold. An Initial Development Team that prior to the effective date of this Circular sold Digital Assets in the Philippines may rely on this exemptive relief if the conditions of paragraph (a) are satisfied. In this case, the application for regulatory sandbox and Notice of Reliance must be filed within ninety (90) days from the effectivity of this Circular.
(h) Definition of Qualified Buyer. For purposes of Section 10(l) of the SRC, a “Qualified Buyer” includes any person to whom Digital Assets are offered or sold in reliance on paragraph (a) of this section.
(i) Disqualifications. No exemption under this section is available for the Digital Assets of any Initial Development Team if it or its individual members would be subject to disqualification under the relevant provisions of the SRC, Investment Company Act, Revised Corporation Code, or any other laws administered by the SEC.
(j) Definitions. For purposes of this Section, the following terms are defined as follows:
1. “Initial Development Team” means any person, group of persons, or entity that provides the essential managerial efforts for the development of the network prior to reaching Network Maturity and makes the initial filing of a Notice of Reliance on this exemptive relief.
2. “Network Maturity” refers to the status of a decentralized or functional network, protocol or decentralized application that is achieved when the network, protocol or decentralized application is either: (a) not economically or operationally controlled and is not reasonably likely to be economically or operationally controlled or unilaterally changed by any single person, entity, or group of persons or entities under common control, except that networks for which the Initial Development Team owns more than twenty percent (20%) of Digital Assets or owns more than twenty percent (20%) of the means of determining network consensus cannot satisfy this condition; or (b) functional, as demonstrated by the holders’ use of Digital Assets for the transmission and storage of value on the network, the participation in an application running on the network, or otherwise in a manner consistent with the utility of the network: Provided that, the above definition of “Network Maturity” is not meant to preclude network alterations achieved through a predetermined procedure in the source code that uses a consensus mechanism and approval of network participants.
3. “Related Person” means the Initial Development Team, directors or advisors to the Initial Development Team, and any immediate family member of such persons;
4. “Digital Asset” means a digital representation of value or rights that has a transaction history that: (a) is recorded on a distributed ledger, blockchain, or other digital data structure; (c) has transactions confirmed through an independently verifiable process; (d) practically immutable; (ii) capable of being transferred between persons without an intermediary party; and (iii) does not represent a financial interest in a company, partnership, or fund, including an ownership or debt interest, revenue share, entitlement to any interest or dividend payment.
The new section we proposed above was substantially borrowed from the Token Safe Harbor Proposal of Commissioner Hester Peirce of the United States Securities and Exchange Commission (US SEC). The purpose of the digital asset safe harbor exemptive relief is to allow projects to build its blockchain, digital asset network, protocol or decentralized application, and provide them reasonable time to develop a mature network that is sufficiently decentralized and fully functional, without being hampered by legal or regulatory issues implicated by the issuance of Digital Assets.
Per our proposal, there should be no hard and fast rule on what is reasonable time for purposes of the safe harbor. Commissioner Peirce’s original proposal was three (3) years. We believe that the SEC should determine this reasonable time on a case-by-case basis, taking into account the applicant’s proposed timeline for development and testing.
In adopting Commissioner Peirce’s proposal, the above draft also intends to generally adopt the rationale and interpretation advocated by Commissioner Peirce, as articulated in her public statements. For instance, we quote with approval the following explanation of Commissioner Peirce on the problem sought to be resolved by her safe harbor proposal:
A core benefit of a token network is its non-reliance on intermediaries; people transact directly with one another. Having to buy or sell tokens through a registered broker-dealer or on a registered exchange certainly puts a damper on the development of a thriving, decentralized crypto network. Particular problems arise because there are unique challenges related to broker-dealers and exchanges handling digital assets.
Other projects have sought to sever any ties with the United States to avoid the reach of our securities laws. This approach is risky because invariably some activity occurs in the United States. Moreover, this approach is detrimental to the US economy because it prevents American citizens from participating in budding token networks. It is evident that any route chosen by a team to distribute tokens into the hands of potential users is fraught with uncertainty under the securities laws.
We have created a regulatory Catch 22. Would-be networks cannot get their tokens out into people’s hands because their tokens are potentially subject to the securities laws. However, would-be networks cannot mature into a functional or decentralized network that is not dependent upon a single person or group to carry out the essential managerial or entrepreneurial efforts unless the tokens are distributed to and freely transferable among potential users, developers, and participants of the network. The securities laws cannot be ignored, but neither can we as securities regulators ignore the conundrum our laws create.
There is, I think, a way to address the uncertainty of the application of the securities laws to tokens. The safe harbor I am laying out this morning recognizes the need to achieve the investor protection objectives of the securities laws, as well as the need to provide the regulatory flexibility that allows innovation to flourish. Accordingly, the safe harbor protects token purchasers by requiring disclosures tailored to their needs, preserving the application of the antifraud provisions of the securities laws, and giving them an ability to participate in networks of interest to them. The safe harbor also provides network entrepreneurs sufficient time to build their networks before having to measure themselves against a decentralization or functionality yardstick.
However, unlike the Peirce proposal, our proposed new section grants the digital asset safe harbor exemptive relief only in favor of regulatory sandbox participants. Consequently, this will encourage token issuers (regardless of token characterization) to apply and participate in the SEC’s regulatory sandbox. The other changes we introduced were merely intended to localize and harmonize the Peirce proposal vis-à-vis Philippine securities regulatory framework.
The application nor participation in the SEC’s regulatory sandbox should not be regarded as an implied admission that the Digital Asset issued by the applicant or participant constitutes an investment contract or some other type of security. The question on whether a Digital Asset is a security should be assessed independent of and without regard to the sandbox application or participation. More importantly, the question should be addressed at the end of the duration of the sandbox program primarily based on whether the relevant network, protocol or application has become fully functional and sufficiently decentralized.
Determining whether a Digital Asset is a security involves an assessment of economic realities and specific facts or circumstances, guided by the statutory definition of securities under Sec. 3.1 of the Securities Regulation Code, as well as jurisprudential tests like the Howey test. Consistent with the SEC’s previous guidance, cryptocurrencies depending on their nature may partake the nature of a security—which logically means that not all Digital Assets should be classified as security.
Only cryptoassets that behave like a security should be regulated under the securities regulatory framework; non-security and nonfinancial cryptoassets—depending on their nature, function or underlying economic transaction—should be governed by other applicable laws. If after the duration of sandbox program, the relevant network, protocol or decentralized application has matured to become fully functional and sufficiently decentralized, then the Digital Asset issued by the network, protocol or decentralized application should be not be required to undergo securities registration (unless specific facts or circumstances indicates otherwise).
Conclusion; SEC’s Regulatory Sandbox Framework exemplifies policy innovation that is encouraged by the Philippine Innovation Act
The statutory policy of the Philippine Innovation Act seeks to foster innovation as a vital component of national development and sustainable economic growth. In accordance with Section 10, Article XIV of the Constitution that recognizes science and technology as essential for national development and progress and gives priority to research and development, invention, innovation and their utilization, it is the intent of the law to place innovation at the center of development policies, guided by clear and long-term goals that consider the Philippines’ key advantages and its opportunities in the regional and global economic arena. As such, innovation efforts should be harnessed to help the poor and the marginalized and to enable micro, small and medium enterprises (MSMEs) to be a part of the domestic and global supply chain.
The law recognizes the importance of an effective and efficient innovation ecosystem that addresses and delivers action in various policy areas, including finance. This requires the various departments and agencies of government to implement a “whole of government” approach that will ensure policy coherence, alignment of priorities, and effective coordination in program delivery. This ecosystem should facilitate and support innovation efforts across various industries, including the financial sector. Governance has an indispensable role in enabling and maximizing the benefits from the country’s innovation policy.
Indeed, one of the objectives of the Philippine Innovation Act is to remove obstacles to innovation by suppressing bureaucratic hurdles, and adapting the regulatory framework to support the creation of and diffusion of new knowledge, products, and processes. Innovation is defined by law as “the creation of new ideas that results in the development of new or improved policies, products, processes, or services which are then spread or transferred across the market.”
Section 5 of the Philippine Innovation Act mandates the government to adopt a broader view in developing its innovation goals and strategies covering all potential types and sources of innovation, including product innovation and policy innovation. Product innovation refers to the introduction of a good or service that is new or significantly improved with respect to its features, applications, characteristics or intended uses. On the other hand, policy innovation means the introduction of new or significantly different solutions to policy problems.
Financial technologies and their applications are examples of product innovation. The SEC’s Regulatory Sandbox Framework exemplifies policy innovation. But while the Philippines’ innovation goals should be directed at developing new innovative technologies, the country should also harness global knowledge and technology that would aid in developing new processes or services for increasing productivity and for promoting overall public welfare.
Many of the prudential regulations established by existing laws contemplate traditional business models that did not envisage new approaches and innovations introduced by financial technology. In several instances, fintech firms are like square pegs in round holes where regulators try hard to insert new financial applications into legal paradigms originally designed for traditional institutions. Existing financial regulations and broad principles might apply in theory, but in reality they are practically difficult if not impossible to observe.
The law does not require the impossible to be done. This legal principle reflected even in ancient maxims ad impossibilia nemo tenetur (“nobody must keep a commitment to do impossible things”) and impossibilium nulla obligatio est (“there is no obligation to do impossible things”) may justify a departure from strict application of statutory requirements in cases where it is legally impossible for an actor to obey them to the letter. Laws should be interpreted in a way that will make it practically workable. Financial service laws should not be construed as requiring compliance with what cannot be legally accomplished, considering the peculiar circumstances of certain technology-enabled activities. In such cases, the law “should instead be construed in such a way that substantial compliance with what the law requires is sufficient.”
The sandbox approach can therefore enable the feasible execution of laws administered by the SEC as contextually applied to emerging financial technologies or new intermediaries. The SEC can indeed calibrate the application of existing securities law, guided by materiality and proportionality. This policy is consistent not only with the Philippine Innovation Act, but also with Section 72.1 of the SRC that gives the SEC the authority, “by rule or order, conditionally or unconditionally exempt any person, security, or transaction, or class or classes of persons, securities or transactions, from any or all provisions of this Code.”
Thank you very much for this opportunity to submit this Comment. Please let us know if you require further information to enable the SEC, PhiliFintech Innovation Office, and other departments to address the legal and regulatory considerations we have raised in this Comment.
With you in service,
For and on behalf of BLOCK DEVS ASIA, INC.
ATTY. RAFAEL ANGELO PADILLA
This article is published on BitPinas: BlockDevs Asia Comments on SEC Regulatory Sandbox for Emerging Technologies
Some crypto wallets are simply software that provides a convenient interface to allow users to easily engage in a peer-to-peer transaction on a blockchain (unhosted or self-custodied wallet), while other wallets are provided by an intermediary as a custodial service where the user is given a transaction account where the amount of cryptocurrencies deposited by the user to the custodian is recorded (hosted or custodial wallets). Custodial wallets fall within the VASP category: administration and safekeeping of virtual assets. ↑
The post-trade settlement process can benefit from distributed ledger technology. By creating a blockchain-based digital registry for both the financial assets and the means of payment, the financial assets and the means of payment can be “tokenized” to facilitate transactions within the registry. This can allow a smart contract to perform an atomic delivery of assets against payment. In what is known in industry jargon as atomic swap, smart contracts enable trading, clearing and settlement to merge into one indivisible process, minimizing the need for the transaction to pass through layers of trusted financial intermediaries. “Atomic” means that the transaction is indivisible and irreducible such that either (a) both delivery and payment is completed, or (b) nothing is completed. By automating data reconciliation, an atomic swap could mitigate the risk of error and the time for settlement and clearing, reducing counterparty risk and the potential for disputes. Smart contracts make it possible for delivery-vs-payment (DVP) schemes to be conducted atomically, cancelling the counterparty risk that one party will lose its asset while the other fails to deliver. A DVP scheme is a securities settlement system which ensures that delivery of securities occurs if and only if payment occurs. (Rafael Padilla, Fintech: Law and First Principles, p. 154 (2020) ↑
Sec. 9, Draft SEC RSF. ↑
Section 1, Exit Stage, BSP Circular No. 1153, p. 6 (2022). ↑
Lee Rainers, Regulation of Robo-advisory Services; Jelena Madir, Fintech, Law and Regulation, p. 375-376 (2019). ↑
Hester Peirce, Token Safe Harbor Proposal 2.0, U.S. Securities and Exchange Commission, 13 April 2021 (https://www.sec.gov/news/public-statement/peirce-statement-token-safe-harbor-proposal-2.0) ↑
Hester Peirce, Running on Empty: A Proposal to Fill the Gap Between Regulation and Decentralization, U.S. Securities and Exchange Commission, 06February 2020 (https://www.sec.gov/news/speech/peirce-remarks-blockress-2020-02-06) ↑
Other laws that might find application under certain circumstances are the Consumer Act (R.A. No. 7394 ) and Electronic Commerce Act (R.A. No. 8792 ). ↑
R.A. No. 11293; An Act Adopting Innovation as Vital Component of the Country’s Development Policies to Drive Inclusive Development, Promote the Growth and National Competitiveness of Micro, Small and Medium Enterprises, Appropriating Funds Therefor, and for Other Purposes (2019). ↑
Sec. 2(a), Philippine Innovation Act (2019). ↑
Sec. 2(d), Philippine Innovation Act (2019). ↑
Sec. 2(e), Philippine Innovation Act (2019). ↑
Sec. 4(e), Philippine Innovation Act (2019). ↑
Sec. 3(f), Philippine Innovation Act (2019). ↑
Sec. 3(r), Philippine Innovation Act (2019). ↑
Sec. 3(o), Philippine Innovation Act (2019). ↑
Rafael Padilla, Fintech: Law and First Principles, Rex Book Store, p. 486. (2020) ↑
Sec. 5, Philippine Innovation Act (2019). ↑
Prudential regulation is the body of rules designed to ensure the safety and soundness of financial institutions and to safeguard financial stability. (World Bank, ). ↑
The SRC’s regulatory regime does not apply solely to the obvious, common and traditional forms of securities. New, innovative and unorthodox schemes, whatever their form, also fall within the SEC’s regulatory perimeter if as a matter of fact they were publicly offered under such terms that would characterize them as an investment contract or security. Indeed, the SRC was enacted to regulate securities, in whatever form they are made and by whatever name they are called. First principles of securities law apply to new paradigms in financial technology, such as when individuals, corporations, or even unincorporated group of individuals purporting to be a “decentralized autonomous organization” use blockchain technology to facilitate capital formation activities, investments and the public offer or sale of new types of securities. The automation of certain functions through blockchain and smart contracts does not remove these activities from the material scope of securities law. ↑
Indeed even under the general principles of civil law, “impossible conditions”, which may include legal conditions, “shall annul the obligation which depends upon them.” Art. 1183, Civil Code. ↑
Nevada v. Slemmons, 43 ALR (2d) 693, 244 Iowa 1068, 59 N. W. (2d) 793.“Hence if a statute apparently requires the performance of things which cannot be performed, or apparently bases its commands upon the assumption of an impossible state of affairs, the courts must seek for some interpretation of its terms, not too strained or fantastic, which will avoid these results.” (Black on Interpretation of Laws, 2nd Ed., p. 121.) ↑
Ruben E. Agpalo, Statutory Construction, p. 253, 6th Edition (2009). ↑