The U.S. Securities and Exchange Commission (SEC) has put forward a proposal to remove key “trade-through” protections within Regulation National Market System (NMS). This regulatory shift, if enacted, is anticipated by industry analysts to significantly lower existing barriers for the trading of tokenized U.S. equities on decentralized finance (DeFi) platforms.
Key Takeaways
- The SEC has proposed rescinding Rules 611 and 610(e) of Regulation NMS, rules established in 2005.
- This action is intended to foster market innovation and reduce operational costs within U.S. equity markets.
- Analysts suggest the removal of these rules could enable automated market makers (AMMs) in DeFi to engage in the large-scale trading of tokenized U.S. stocks.
- Compliance challenges for AMMs related to trade-through prohibitions and locked/crossed quotations are expected to be mitigated.
- The SEC aims to rely on FINRA Rule 5310’s best execution duty as a primary compliance mechanism post-rescission.
The proposal, announced recently, targets the elimination of specific rules that mandate how trades must be executed across different trading venues. Regulation NMS, initially implemented to ensure fair and orderly markets, contains provisions that have inadvertently created obstacles for the integration of novel trading technologies.
SEC Chairman Paul Atkins stated that the proposal’s objective is to streamline market structure and decrease expenses for market participants. He further indicated that this move would allow competitive forces and ongoing innovation to influence the evolution of U.S. equity markets.
Specifically, Rule 611 prohibits executing a trade at a price inferior to the best publicly displayed bid or offer from another trading venue. Rule 610(e) addresses the display of quotations that are locked or crossed, meaning they do not allow for efficient price improvement across different markets.
The SEC has initiated a 60-day public comment period, allowing stakeholders to provide feedback on the proposed changes, which also encompass related definitions within Regulation NMS.
Potential Regulatory Precedent for Tokenized Assets
Industry experts view this SEC proposal as a pivotal moment for the tokenization of securities. Alex Thorn, Head of Firmwide Research at Galaxy Digital, described the move as “one of the biggest unlocks yet” for tokenized U.S. equities within the DeFi ecosystem.
Thorn elaborated that Rule 611’s prohibition on trade-throughs presented a fundamental structural impediment for on-chain trading of tokenized equities. He explained that automated market makers (AMMs) operate on a principle where trades are executed based on the pool’s current price, which inherently involves slippage and occurs at block-time granularity. This mechanism, by its nature, cannot comply with the strict requirements of Rule 611, such as routing intermarket sweep orders or ensuring real-time data ingestion with guaranteed latency. Consequently, any AMM dealing in tokenized NMS stocks would likely engage in constant trade-throughs, potentially classifying it as an illegal trading center under current regulations.
Similarly, Rule 610(e) poses challenges because AMMs rely on continuous price discovery driven by transaction flow. Their pricing models frequently result in quotes that lock or cross the National Best Bid and Offer (NBBO), a situation that current regulations require trading centers to prevent.
Should these rules be rescinded, the SEC’s regulatory oversight would likely pivot to FINRA Rule 5310. This rule imposes a “best execution” duty on broker-dealers, operating as a principles-based framework that is considered more adaptable to the operational characteristics of AMMs, according to Thorn.
Thorn further suggested that this action aligns with a broader strategy, where the SEC first addresses significant market structure obstacles through rule rescissions, potentially followed by guidance on venue registration requirements, possibly via innovation exemptions.
Timeline and Future Considerations
Jaret Seiberg, a Managing Director at TD Cowen’s Washington Research Group, anticipates that the SEC’s proposal will likely be adopted. He noted that repealing these specific rules has been a long-standing objective for Chairman Atkins and projected that the SEC could finalize the rule changes by the first quarter of 2027.
Seiberg characterized the proposal as “broadly positive for the tokenization of equity securities” due to Rule 611 being a significant impediment. However, he also indicated that the SEC might not wait for the proposal’s finalization before approving tokenization pilots, suggesting that initial tokenization efforts could receive exemptive relief from Rule 611 in the interim.
Despite these potential advancements, tokenized U.S. equities operating within DeFi still face additional regulatory hurdles. These include requirements for exchange or Alternative Trading System (ATS) registration, as well as regulations pertaining to clearance and settlement, many of which were not designed with decentralized or peer-to-peer trading models in mind. Galaxy Digital’s Thorn expressed optimism that many of these remaining issues might be addressed through the SEC’s forthcoming “innovation exemption” framework.
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