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The Tokenization of Research: Innovation & Compliance

There is an opportunity to leverage innovative technology and new payment and consumption methods to satisfy the requirements and enable the desirable benefits of both MiFID II research unbundling and Section 28(e) of the US Securities Act of 1934. UAT’s Joel Steinmetz and Allan Chiulli examine the structure and operations of a token, smart contract and blockchain-based platform for U.S. equity research that incorporates Section 28(e) practices in a post-MiFID II environment.

This is Part 2 of a Multi-Part Series. In Part 1 (The Tokenization of Research), we examined the regulatory differences between MiFID II and Section 28(e) of the Securities Act of 1934 and the expected financial impact of MiFID II on asset managers and brokerage firms. The options for asset managers and brokerage firms are: adopt MiFID II requirements on a global basis; maintain two systems, one for the US and one for Europe; or stop doing business in Europe.

We also introduced the possibility of simultaneously satisfying the MiFID II regulatory and financial challenges and capitalizing on the benefits provided by both regulatory environments through the introduction of innovative technology and new payment and consumption methods that incorporate tokens, smart contracts, blockchain and platform technology. Such a system would permit the use of 28(e) in the U.S. while satisfying MiFID II requirements on a global basis.

A Token, Smart Contract and Blockchain-Based Research Platform

MiFID II creates the need for a system that optimizes operations and benefits from both MiFID II and 28(e). Satisfying one set of regulations or the other is less than optimal as a long-term solution when both systems clearly offer desirable benefits.

A token, smart contract and blockchain-based research platform enables new business methods to comply with MiFID II requirements while simultaneously enabling asset managers continued use of 28(e) in the U.S. Some of the features of such a Research Platform include:

  • **Asset Manager and Brokerages Utilize a Research Platform Leveraging Blockchain Technology:**Participants have restricted membership, access and updating rights.
  • **Asset Manager Trades Earn Non-Currency Research Tokens:**The executing broker awards non-currency tokens redeemable for research to the asset manager originating the trade order.
  • Smart Contracts Govern the Tokens Awards: Brokerages utilize algorithm-driven smart contracts to determine the research tokens issued following the execution of an order.
  • **Each Piece of Research is Priced in Tokens:**Research items have a stated token redemption requirement to access the research item.
  • **An API-Driven Research Platform Enables Asset Managers to Select Research:**An API provides the asset manager with a capability to access, search and acquire research through a continuously updated database of research products from the research providers on the platform.
  • Asset Managers Redeem Tokens for Research: Tokens are redeemed by the asset manager for the selected research item.
  • Token Awards and Redemptions Are Recorded in the Blockchain: All token award and redemption activity, along with token balances and contra balances for each asset manager and brokerage firm, is recorded in an immutable form on the research platform’s blockchain.

Benefits of the Research Platform

The token, smart contract and blockchain-based research platform represents a fundamental, long-term solution to multiple internal and external challenges facing the execution and research industry. These benefits include:

  • Automating business processes;
  • Streamlining and standardizing data practices;
  • Increasing the reliability of data quality;
  • Reducing exemption correction time; and
  • Improving transparency.

However, the research platform provides more than cost savings and improved efficiency. The research platform enhances MiFID II’s compliance by streamlining the acquisition, valuation and audit trail for each piece of research. Individual company commission management systems are transformed into an immutable, distributed and encrypted private blockchain. In effect, there is a “cloud effect” whereby proprietary, expensive and high-maintenance commission management systems operating at a high fixed cost are replaced by a cloud-based distributed ledger (blockchain) operating at a variable, usage-based cost. These benefits favor a network adoption.

However, the most important benefits from blockchain-based systems are the new and innovative business models that are enabled by this platform. For example, the use of tokens constitutes a customer rewards program that provides non-currency units of exchange (tokens) to asset managers for their trades. These tokens bear a rough resemblance to “frequent flyer miles.” These tokens represent a non-currency store of value that, as we shall see, enable further innovation in the U.S.

Also, mechanisms within the research platform enable the cross-redemption of tokens and, thereby, access to research from brokerage firms other than the issuing brokerage firm. Such a capability could potentially satisfy MiFID II’s requirement to eliminate any inducement to execute through a brokerage firm based on the quality of its research. The result is a system that:

  • Addresses MiFID II requirements and delivers a methodology for valuating and tracking research;
  • Delineates execution and research costs;
  • Leverages blockchain technology to expand the universe of research for providers and consumers; and
  • Creates a competitive research marketplace.

Lastly, the token, smart contract and blockchain-based research platform also enables a new payment option in the U.S. that we call “28(e) Execution.” Such an approach may satisfy MIFID II requirements to delineate and value research costs while also providing sustainable profitability to and continued innovation by asset managers and brokerage firms in the U.S. We will examine “28(e) Execution” in future contributions.


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