The Best Damn Comment Letter Period
Toward a Framework for Tokenized Sovereign Bonds
I started Brogan Law to provide top-quality legal services to individuals and entities with questions related to cryptocurrency. Cryptocurrency law is still new, and our clients recognize the value of a nimble and energetic law firm that shares their startup mentality. To help my clients maintain a strong strategic posture, this newsletter discusses topics in law that are relevant to the cryptocurrency industry. While this letter touches on legal issues, nothing here is legal advice. For any inquiries email aaron@broganlaw.xyz
Update! I announced this already during the newsletter on Thursday, but for anyone that missed it, we are extremely excited to have Veronica Irwin as a Wednesday columnist. Veronica is a highly accomplished reporter who previously wrote for Unchained and Forbes, has bylines in The Nation and Fast Company, and was recently featured as an expert on the cryptocurrency industry on the BBC. Her reporting is incredible and I’m really excited to see the inside cryptocurrency information that she’ll break here in the coming weeks. Check out her article from last week below, and subscribe to receive updated industry scoops every Wednesday.
Tokenized Bonds, the SEC, and a Path Forward
If you’ve been watching the cryptocurrency industry for the last few months, you’ve probably noticed a profusion of comment letters popping up on X or elsewhere. Basically, when Trump took office, he promised change in the regulation of cryptocurrency, and the way he delivered that was handing over the reins of the SEC to a few pro-crypto commissioners.
First among these is Commissioner Hester Peirce, who has published a remarkable series of writings on topics in cryptocurrency in recent months (a “heater,” the kids call it). And one of these writings, There Must Be Some Way Out of Here, called on the industry to submit comments to a wide range of questions relevant to the securities laws. I was impressed by the effort when I wrote about it back then, and we have covered a few of these submissions here since.
Well, last week Brogan Law and our client Etherfuse submitted a comment letter of our own, titled Toward a Framework for Tokenized Sovereign Bonds. This week, I want to give some space to the issue we addressed here.
We argue that tokenized foreign sovereign bonds could offer real value to the U.S. market, that they are prohibitively difficult to access now, and that the SEC could change that with authority it already has now. To accomplish this, we propose a new category of foreign debt, “Qualifying Foreign Government Securities” (QFGSs) that would enjoy broad exemptions across the securities laws.
Bonds may not be flashy, but this reasoning and approach have much broader applications to the tokenization of assets broadly. And a solid framework built on low-risk assets can set the stage for future primary offerings of new securities to take place wholly on-chain.
The laws preventing this from happening are a thicket, and we used this letter to try to cut through them. I’ll use the rest of this newsletter to summarize our arguments, and you can find the full letter below to follow along at home.
Note: Etherfuse products are not available in the United States or to U.S. Persons. This letter has been redacted to remove all product descriptions and is intended solely as a policy discussion about the regulation of tokenized sovereign bonds, not as an offer of any product.
The Case for Tokenized Sovereign Bonds
The threshold point that we make in the letter is that foreign sovereign bonds are underutilized financial assets with strong fundamentals. In the spectrum of traditional financial products, investors look to properties like yield, volatility and risk. Evidence suggests that foreign sovereign bonds can offer higher yield than domestic bonds, with lower volatility than domestic stocks.
Moreover, according to Fitch, investment grade foreign sovereign bonds rarely, if ever, default.
This is likely why historical data shows that “global funds provide higher returns and comparable risk adjusted returns to domestic bond funds [and] global bond funds provide incremental gain for investors whose portfolios are concentrated on domestic bond funds.”
This combination of properties could make these assets valuable to risk averse purchasers, like those who need rapid liquidity. Bonds denominated in foreign currency might also be valuable tools for FX hedging in industry.
Tokenization, in turn, could add substantial incremental value to these products. Tokenized products are generally available 24/7 rather than during market hours and can also be sold in smaller volumes than commercially available bond lots. They may also facilitate rapid, disintermediated cross-border transactions.
Access to Foreign Sovereign Bonds is Limited in the United States
Despite these attributes, foreign sovereign bonds are generally difficult to access in the United States. This is primarily because foreign governments are required to register each offering in order to sell them into the United States, which they generally do not do. While there are “shelf offering” options, these are rarely used, and even when they are, these bonds are often sold in lots of such large volume as to be impractical. Generally, save for ETFs, this means that these products are simply unavailable at retail.
It is, further, difficult to tokenize these bonds for sale in these United States for a variety of reasons. Specific to these products, we identified the treatment of pools of foreign sovereign bonds under the Investment Company Act of 1940 (the “‘40 Act”) as a major barrier.
Section 3(a)(2) of the ‘40 Act excludes funds composed of “government securities” from registration, but Section 2(a)(16) defines government securities narrowly to include only U.S. government debt. This means that a domestic tokenization project using foreign sovereign bonds would likely be required to rely on other exemptions from the ‘40 Act, which would dramatically narrow the number of purchasers they could engage to only those purchasers who could otherwise fit within the Section 3(c)(1) and 3(c)(7) exemption from ‘40 Act registration.
A Tokenization Sandbox and Targeted Relief Could Remedy the Situation
Building on these points, we make several policy arguments that would improve the regulatory treatment of tokenized foreign sovereign bonds. In the first instance, we endorsed Commissioner Peirce’s proposed regulatory sandbox for the tokenization of securities. To do so, we built on a number of other comment letters from the Solana Policy Institute, Plume, and Robinhood which all made similar endorsements of this model.
Unique to us, though, we proposed targeted exemptive relief to improve the treatment of foreign sovereign bonds specifically. You see, each of the securities laws includes its own exclusions for a variety of securities. I mentioned that “government securities” are exempt from ‘40 Act registration. The Securities Act of 1933 (the “Securities Act”) includes its own category of “exempted securities” and the Security Exchange Act of 1934 (the “Exchange Act”) has “government securities.”
We propose using the SEC’s exemptive rulemaking authority under Section 28 of the Securities Act, Section 36 of the Exchange Act, and Section 6(c) of the ‘40 Act to create a new category across the securities laws we call Qualifying Foreign Government Securities. This category need not include all government debt, but could consider the broad, publicly available disclosures already available from IMF and credit-rating agencies Moody’s, Fitch, and S&P to identify criteria to qualify a subset of foreign sovereign bonds for unregistered offering in the United States and exemption under the ‘40 Act.
This relief would improve access and ease tokenization, for all the reasons listed above, and would also harmonize the treatment of QFGSs with the existing category “designated foreign government securities” under Exchange Act Rule 3a12-8. It would also bring the U.S. into global parity with international practices, like the recent U.K. rule that permits “sovereigns, local and regional authorities and central banks of any country… to offer debt securities to the public or to list such securities on the main market of the London Stock Exchange.”
What it All Means
Much of cryptocurrency policy in recent months has been focused on various pieces of legislation that advocates argue would improve the regulatory treatment of cryptocurrency products in the United States.
While legislation could, indeed, be powerful tools to open U.S. markets, my perspective on these regimes has changed substantially in recent months. The thing about the cryptocurrency industry is that the technology is just a base layer, and constructing products on top of that necessarily implicates novel issues, questions, and approaches to law.
The instinct to draft legislation that permits exactly what projects are currently doing, or even an idealized version of what projects are doing, risks narrowing the cone of future innovation. Cryptocurrency industry participants are understandably nervous to empower any regulatory authority with discretion to oversee the industry, but flexibility could ultimately be empowering. Specific frameworks are difficult to engage with, just look at the failure of Regulation Crowdfunding. Broad ones, like Reg D, tend to succeed and grow.
Drafts of market structure legislation require projects to meet highly specific criteria to participate. Will these criteria still be relevant in twenty years? I do not know. It concerns me that we are choosing a path, in this legislation, that most of the industry does not conform to today. If the result is bad law, it will be much harder to recover than it would be with no law at all.
If I held the pursestrings today, I would devote all my energy to convincing the SEC to come along for tokenization and the liberalization of the securities laws. The exemptive authorities have limitations, principally that they probably cannot effect preemption of overlapping state “blue sky” laws, but I think an approach to regulatory reform that first opens spaces for industry participants to offer products under the existing securities laws, and then pursues legislation to remedy problems that cannot otherwise be solved through existing authority, is likely to be far more robust than one that goes the other way.
It was incredibly fun to think about these issues with Etherfuse, and over recent months, Brogan Law has worked with a number of RWA issuers on similar issues domestically. This industry segment is still in its fledgling stages, and the laws are not yet open enough for it to really flourish in the United States, but if we practitioners put our heads together and rework these rules, this segment of the industry could completely transform the operation of capital markets. And we would all be the richer for it.
I am grateful to Commissioner Peirce, the Crypto Task Force, and the Commission as a whole for this opportunity to do so, and I hope to continue this thread in the future. But that's all for this week!
Brogan Law is a registered law firm in New York. Its address and contact information can be found at https://broganlaw.xyz/
Brogan Law provides this information as a service to clients and other friends for educational purposes only. It should not be construed or relied on as legal advice or to create a lawyer-client relationship. Readers should not act upon this information without seeking advice from professional advisers.