SEC Plans to Restrict Hedge Funds Exposure to Crypto With New Proposal

The U.S. Securities and Exchange Commission (SEC) has proposed a draft that would make it harder for hedge funds, private equity firms, and pension funds to work with crypto companies. 

The proposal would make it difficult for crypto firms to hold digital assets on their client’s behalf as “qualified custodians,” a designation that allows companies to hold client assets for money managers, Bloomberg reported Tuesday, citing people familiar with the matter. 

A five-member SEC panel will vote on the proposal on Wednesday, deciding whether the proposal proceeds to the next stage. A majority vote will be needed for the rest of the SEC to vote on the proposal officially. If approved, the proposal will be amended with feedback where necessary.

Hedge funds, some VC firms, and pension funds need to use “qualified custodians” to hold their clients’ assets. The new rule change might force some of these companies to change their custodian. The report said:

“If finalized, the rule could mean that institutional funds that have delved into crypto might have to move their customers’ holdings elsewhere. They may also face surprise audits related to their custodial relationships or other ramifications.”

Back in 2020, the SEC deliberated on the question of who should be required to be a qualified custodian of cryptocurrencies. However, the recent implosion of FTX, once the third-largest crypto exchange in the world that failed in November last year, forced the agency to look at this question with renewed gravity.

SEC Launches Crypto Crackdown

The move comes as the SEC has ramped up efforts to mitigate the risks that cryptocurrencies pose to the broader financial system by cracking down on crypto companies. 

Last week, the SEC reached an agreement with crypto exchange Kraken to stop offering staking services or programs to clients in the country and pay $30 million to settle allegations that failed “to register the offer and sale of their cryptoasset staking-as-a-service program,” which the commission qualified as securities. 

Furthermore, the agency has threatened Paxos, a US-registered firm that issues Binance’s stablecoin Binance USD (BUSD), with legal action due to its issuance of BUSD tokens. The agency argued that BUSD is considered an unregistered security.

Furthermore, Reuters reported in late January that the SEC has been probing traditional Wall Street investment advisers that may offer digital asset custody to its clients without the proper qualifications.

Earlier this year, the White House also detailed its plans to address potential risks from cryptocurrencies in a roadmap that calls for authorities to “ramp up enforcement where appropriate” and Congress “to step up its efforts” to regulate the industry.