Source: Grayscale; Compilation: Song Xue, Lian Guai
On August 29, 2023, a panel of the United States Court of Appeals for the District of Columbia Circuit overturned the SEC’s decision in June 2022 to deny the conversion of Grayscale Bitcoin Trust (GBTC) to a physically-backed Bitcoin ETF. This is an important milestone in the GBTC conversion process—a victory. It has been celebrated by GBTC shareholders, the Grayscale team, and the wider Bitcoin, cryptocurrency, and investment community.
Today, following the opinion of the reviewing court, our legal team, along with attorneys from Davis Polk & Wardwell and Munger Tolles & Olsen, sent a letter to the SEC, which includes important information to consider when deciding the next course of action.
Below is the content of the letter, translated by Lian Guai:
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Dear Mr. Zhu, Ms. Barbero, and Ms. Countryman:
On behalf of our client, Grayscale Investments, LLC, the sponsor of the Grayscale Bitcoin Trust (BTC), we are pleased to have the opportunity to meet with the staff of the Securities and Exchange Commission (SEC) to discuss the future direction as the Trust continues its efforts to convert to an exchange-traded product (ETP).
On June 29, 2022, the Commission denied NYSE Arca, Inc.’s request to list and trade the Trust Fund under Section 19(b)(1) of the Securities Exchange Act of 1934 (as amended, the “Exchange Act”) and Rule 19b-4. Subsequently, Grayscale sought to have the Commission’s denial of the Trust’s Exchange Act application reviewed by the United States Court of Appeals for the District of Columbia Circuit, and on August 29, 2023, the appellate court overturned the Commission’s denial.
After the Commission has had the opportunity to fully analyze the court’s opinion, including the reasons for denial set forth in the rescission order and the evidence and arguments presented by Grayscale, NYSE Arca, and public commenters, we believe the Commission should conclude that there is no basis to treat the Trust differently from an ETP that invests in Bitcoin futures contracts traded on the Chicago Mercantile Exchange (“CME”), which filed its Rule 19b-4 submission with the Commission. Therefore, the Trust Fund’s Rule 19b-4 filing should be promptly approved.
If there are any other reasons that can be attempted to distinguish physically-backed Bitcoin ETPs from Bitcoin futures ETPs—whether based on the requirements of the Exchange Act, which states that the rules are “designed to prevent fraudulent and manipulative acts and practices,” or for any other reasons—we believe that it would still appear in the 15 Commission orders, one of which denied the application of physically-backed Bitcoin’s Rule 19b-4.
Grayscale raised this issue approximately two years ago (before all of these opposing orders), explaining why it would be unreasonable to deny its Rule 19b-4 application once the Commission determined that it could approve physically-backed Bitcoin ETPs under the control standard of Section 6(b)(5) of the Exchange Act.
But since the appellate court has spoken, based on the legal analysis previously rejected by the committee when it refused the spot bitcoin ETP, there is no reason to distinguish between bitcoin futures ETP and spot bitcoin ETP. As the committee has consistently explained, this is because:
Listing exchanges for bitcoin-based ETPs can fulfill their obligations under Section 6(b)(5) of the Exchange Act by demonstrating that the exchange has entered into comprehensive regulatory sharing agreements with large-scale regulated markets that are related to the underlying or reference bitcoin assets.
This is the test, and the appellate court has explicitly found that this requirement has been met:
Grayscale has demonstrated that its proposed bitcoin ETP is very similar to approved bitcoin futures ETPs in terms of relevant regulatory factors. First, the underlying assets – bitcoin and bitcoin futures – are closely related. Second, the monitoring sharing agreement with CME is the same and should have the same ability to detect fraud or manipulation in the bitcoin and bitcoin futures markets.
The pending time for the rule submitted under Rule 19b-4 for the trust fund is now approaching three times the time allowed for the committee to take action under Section 19(b) of the Exchange Act. NYSE Arca initially submitted the proposed rule change for the trust fund on October 19, 2021, and the committee published the proposal in the Federal Register on October 19, 2021.
Pursuant to the requirements of Section 19(b)(1) on November 8, 2021. Pursuant to Section 19(b)(2)(A)(i), a 45-day time period was initiated during which the committee would decide to approve or disapprove. Section 19(b)(2)(A)(ii) grants the committee the power to extend this deadline for an additional 45 days until February 6, 2022, and the committee exercised this extension power on December 15, 2021. On February 4, 2022, the committee filed a lawsuit under Section 19(b)(2)(B), in which the agency is obligated to approve or disapprove by May 7, 2022 (180 days after the originally scheduled November 8, 2021 publication date), with a final deadline of up to 60 days. On May 4, 2022, the committee extended the deadline and rejected the application on June 29, 2022 – just a week short of the longest eight months remaining for final action by Congress.
Therefore, the committee’s review of the trust fund rule 19b-4 filing is now clearly longer than the time allowed under Section 19(b). Pursuant to Section 19(b)(2)(D), if the agency does not issue an order in some form within the statutory time period, the proposed rule change will be deemed approved by the committee. We question the validity of a subsequent disapproval order. The appellate court completely dispels the committee’s obligation to take action within the necessary time limits in order to avoid being deemed approved under Section 19(b)(2)(D). But assuming deemed approval does not apply – at least when the committee immediately reconsiders the filing based on the court’s reasoning – we believe the committee should consider three points when considering the next steps.
First of all, every day that the trust fund is not listed on NYSE Arca, existing investors of the trust suffer unreasonable damage due to its trading price being significantly lower than the net asset value. If the trust receives the same treatment as the Bitcoin futures ETP that the Commission has approved under its Rule 19b-4 filing, this damage can be avoided. In fact, on the day the appellate court announced its ruling, the discount rate tightened by more than 600 basis points, which means that over $2 billion in assets were returned to investors in a single trading day, even at a price that was more than $3 billion below the net asset value of the trust. If the trust is approved to operate as an ETP, it will trade.
Secondly, U.S. investors seeking regulated Bitcoin investment products should not be forced to adopt less efficient and more complex products solely because they are the only product type that has not yet received Commission approval. Spot ETPs have been favored by investors, as demonstrated by their commercial success in other commodities such as gold. Over time, investors and spot Bitcoin product issuers like Grayscale cannot benefit from Bitcoin futures ETPs and suffer competitive harm – unlike Grayscale, Bitcoin futures ETPs can use time-tested ETP wrappers to increase the assets under management. As a specific example of this harm, on the day the appellate court made its ruling, Bitcoin futures ETP10 benefited from net inflows, with daily average net fund flows increasing by over 800% compared to the previous 30-day period. It can be reasonably assumed that if the trust also operates as an ETP that day, it will attract the majority of investments.
Thirdly, in the past few weeks, the Commission has received filings under Rule 19b-4 related to multiple proposed spot Bitcoin ETPs, each of which attempts to compete with the trust fund. As Grayscale pointed out in its comment letter responding to these filings, every company among the 12 listed exchanges proposed to enter into surveillance sharing agreements with major U.S. Bitcoin spot trading venues. Grayscale’s letter explains that the Commission’s previous Bitcoin futures ETP approval order clearly stated that entering into a surveillance sharing agreement with CME alone is sufficient to satisfy the requirements of Section 6(b)(5) of the Bitcoin futures ETP. Therefore, based on the appellate court’s reasoning, we believe the Commission may not impose additional new requirements on spot Bitcoin ETPs and may reach a surveillance sharing agreement with the spot Bitcoin market.
With the approval of the Commission, the trust is ready to operate as an ETP. Therefore, we hope that you agree that the best course of action now is for the Commission to issue an order approving NYSE Arca’s Rule 19b-4 filing and authorize staff to work with Grayscale and NYSE Arca to expedite the listing of the trust fund. We believe that the trust fund’s millions of investors should have access to this fair competitive environment as soon as possible.
We look forward to discussing the above issues with the committee and its staff.