During one of yesterday’s panels at the U.S. Securities and Exchange Commission (SEC) roundtable on tokenization, incumbents were urged to avoid attempting to hamstring new technology players. BlackRock’s Robert Mitchnick said that rather than forcing startups to comply with obsolete regulations, there’s a need to modernize. This tension between innovation and regulation set the tone for the discussion that followed. A key goal of the roundtable was to find out what regulatory issues need addressing.

Five of the nine panelists work for major asset managers: Apollo, BlackRock, Fidelity, Franklin Templeton and Invesco. These institutions stand to benefit most from embracing public blockchains, by exploiting efficiencies and reducing layers of intermediaries. Two of the panelists represented intermediaries: the DTCC and Nasdaq. While they gave fairly balanced perspectives, they advocated for the most caution, particularly Nasdaq.

The key topics covered were how to define tokenization, interoperability, practical use cases and the need for regulatory changes.

The tokenization opportunity most discussed currently in the traditional finance (TradFi) sector is tokenized collateral management, and the panel was no different.

BlackRock’s Mitchnick described the current process of using money market funds for collateral without tokenization. “You first have to liquidate it (the money market fund), deliver cash, and then instruct reinvestment into a money market fund, which is obviously a very inefficient and friction filled system, which can also add sell pressure in times of market stress,” he said. That’s because liquidating funds to meet margin calls ends up creating a sell spiral, requiring more margin calls.

By contrast, with a tokenized money market fund, you don’t have to wait for daily redemptions. You can sell it in the secondary market and post stablecoins as collateral in real time. Alternatively, you can instantly transfer the money fund as collateral. And collateral plays an important role for derivatives, repo and securities lending.

Franklin Templeton’s Sandy Kaul pointed to the potential to not just tokenize the fund, but also the underlying Treasury securities. She emphasized how important this can be in a crisis. Lehman Brothers lawsuits took years to figure out who owned the collateral.

She explained, “If we could immediately move from the tokenized money market fund and into the tokenized assets that sit within that fund, we can immediately get the collateral and begin to unwind all of the obligations in the marketplace.”

Johnny Reinsch from the Tokenized Asset Coalition noted that this was already demonstrated with the collapse of the Terra stablecoin when the market dislocation saw DeFi lending protocols unwind loans and return collateral in an orderly fashion. While DeFi protocols demonstrated resilience during the Terra collapse, the comparison with centralized crypto lending services is telling. Most of them went bust, largely because their loans were under collateralized.

One topic that’s been discussed for years is how much capital institutions keep at different venues to address settlement risks. Arguably this is the side effect of siloed collateral. “The amount of capital that’s locked up for settlement risks and the amount of capital that’s not able to be freely deployed is just immense,” said Alex Zozos of Superstate, the other representative of the crypto world.

He was keen to emphasize how DLT contributes to automating financial primitives. Collateral is one. Lending is another. So is trading using automated market makers. On that point, Franklin Templeton’s Sandy Kaul highlighted that it’s not just about protecting investors, but also creating more opportunities for them. For example, they can earn revenues by participating in liquidity pools for automated market makers.

Additionally, she spoke about the benefits of using blockchain for transfer agency. Interest is calculated by the second, instead of on a daily basis, meaning someone can earn interest up to the point they redeem or sell their investment. Apollo’s Christine Moy also noted the benefits of DLT for transfer agency. It’s possible to use smart contracts to automate most of the transfer agent’s role, including compliance checks. Hence, a digital transfer agent or tokenization agent only needs to manage edge cases like a wallet freeze or a complex corporate action.

Ms Moy also highlighted that blockchains bring together all sorts of different assets onto the same “operating system”, which combined with programmability and composability enables the creation of better investment products.

Tokenization can help to solve an everyday dilemma. Until now, investors have needed to forego some return in order to keep sufficient cash to meet urgent demands. Talking about tokenized Treasuries, Robert Mitchnick discussed “the properties of digital assets that make it possible to convert instantaneously into and out of stablecoins, which function as digital cash, that in effect the investor no longer makes that trade off between yield and liquidity.”

Below is an AI summary of the key regulatory changes discussed:

Modernizing transfer agent rules is viewed as one of the most compelling regulatory opportunities. With tokenized securities, core compliance functions like KYC, AML, and jurisdictional limits can be embedded directly into smart contracts and automated. While smart contracts handle transfers, participants believe a regulatory layer is still needed in the form of “tokenization agents” or “digital transfer agents” to help manage edge cases like wallet recovery, freezes, sanctions compliance, and complex corporate actions.

Participants emphasized that permissionless public blockchains should be recognized as an official record of ownership. This would eliminate duplicative off-chain record keeping, streamline operations, and unlock efficiencies. Several speakers noted the challenges of maintaining both on-chain and off-chain books, with one noting that “it does get really complicated when you try and keep both sets of records.”

Several participants argued that tokenized securities with embedded transfer restrictions through smart contracts should meet the 15c3-3 possession and control requirements, making them eligible to be custodied and traded by broker-dealers without triggering the “three step process” (special purpose broker-dealer requirements).

Panelists advocated that self-custody should be permitted when chosen by investors, noting it enables direct access to innovation, reduces intermediary fees, and supports user control without compromising regulatory oversight.

Participants argued that tokenized securities should be able to be settled using stablecoins, just as cash is used in traditional finance, “without imposing extra regulatory burdens simply because the payment rails are digital.”

The panel discussed how the 1940 Investment Company Act would need adjustments through rule-making, exemptive relief, and no-action relief to accommodate tokenization. Specific areas mentioned included:

-Single book of record at transfer agency level,

-Access and disclosure requirements for investor communication documents,

-Many mutual funds are considering dual share classes – ETF shares. These funds could also potentially be tokenized,

-Forward pricing rule (Rule 22c-1) modifications if 24/7 trading is implemented.

Participants suggested that while industry should lead interoperability efforts, the SEC could provide high-level guideposts or considerations about what interoperability should accomplish and what factors might undermine it, creating “a common set of principles” for dialogue.

There was strong support for formal regulatory sandbox or pilot programs to allow firms to use DLT for issuing, trading, and settling tokenized securities. Participants emphasized these should be practical rather than experimental, focused on directly informing new rules and legislation rather than just testing technology capabilities, which are already proven.

Several speakers highlighted the need for global policy maker coordination and collaboration since technology is cross-border, and regulatory regimes need to recognize tokenized assets as they move across jurisdictions.

The panel emphasized that innovation in this space could bring significant efficiencies to capital markets while maintaining investor protections, but requires thoughtful regulatory adjustments to realize its full potential.