On November 1, 2021, the President’s Working Group on Financial Markets (“PWG”), along with the Federal Deposit Insurance Corporation (“FDIC”), and the Office of the Comptroller of the Currency (“OCC”) (together the “Agencies”), published a long-awaited report on stablecoins (the “Report”). While some commentators believed the Report was set to expand the jurisdiction or regulatory authority of the Securities and Exchange Commission (the “SEC”) over stablecoins, the Report instead reflects a push by the PWG and the Agencies to address perceived risks to consumers, markets, and the broader financial system resulting from a lack of federal prudential regulation of stablecoins. The Report calls for Congress to require that stablecoins be issued solely by banks and recommends a number of agency regulatory actions.
How Does the Report Define Stablecoins?
A stablecoin, as defined in the report, is a digital asset designed to maintain a stable value with a peg to an external reference, often but not always fiat currency. The issuer of the stablecoin maintains this “peg” by holding assets, usually the underlying fiat, as “reserve assets.” As noted in the Report, total market capitalization of stablecoins issued exceeded $127 billion in October 2021, a 500% increase from the period a year earlier.
Currently, stablecoins are predominantly used to facilitate digital asset trading, lending, or the borrowing of other digital assets and to allow market participants to move between different digital asset platforms without the intermediate step of conversion into fiat. While stablecoins are not yet primarily used as methods of payment, the Report specifically focuses its findings on “payment stablecoins,” which it defines as those with the potential to be used as widespread means of payment.
The Report’s recommendations are intended to address three main risks of stablecoins identified by the Agencies: risk of loss of value, risk to payment systems, and systemic risk. The Report also describes risks relating to decentralized finance, or “DeFi,” arrangements and the importance of stablecoins to DeFi.
Recommended Agency Actions and Legislation
The Report provides the following recommendations:
Certain activities in payment stablecoin arrangements be designated as “systemically important payment, clearing, and settlement activities” by the Financial Stability Oversight Council (“FSOC”). Such a designation would allow federal financial regulators to set certain standards regarding risk-management, the assets backing the stablecoin, and requirements related to the operation of stablecoin arraignments.
The Agencies to take collaborative approach to address the risks posed by stablecoins and continued coordination across the federal financial agencies to apply applicable laws to protect investors, the market, and to promote transparency, particularly the SEC and Commodity Futures Trading Commission (“CFTC”).
The Agencies and the Department of Justice to consider whether Section 21(a)(2) of the Glass-Steagall Act applies to certain stablecoin arrangements (which provides that “securities firms,” as defined in the act, are not permitted to accept deposits).
The Consumer Financial Protection Bureau (“CFPB”) to consider how consumer financial protection laws pertain to payment stablecoin arraignments.
Issuers of stablecoins possibly to be deemed to provide “money transmission services” to consumers, triggering federal AML/CFT obligations under the Bank Secrecy Act. Money transmitters, including any issuers of or service providers with respect to stablecoins who meet state licensing requirements are required to register with FinCEN, and in most cases with one or more state regulator.
Congress to act promptly in enacting legislation that addresses the key risks in the Report.
Congress to require that providers of custodial wallets used to hold stablecoins be “subject to appropriate federal oversight.” The Report does not specify any agency that it contemplates as the appropriate federal regulator for custodial wallet providers.
The Report recommends that Congress enact legislation to limit the issuance of stablecoins and activities relating to the redemption of stablecoins and the holding of reserve assets to entities that are insured depository institutions (“IDIs”). This would require stablecoin issuers to be subject to the supervision of a federal banking agency at the depository institution level and regulation by the Federal Reserve at the holding company level.
Several consequences would follow from a policy that required stablecoins to be issued by banks, some of which are mentioned in the Report. For instance, bank-issued stablecoins could be structured to evidence a deposit at the issuing bank that would be eligible for FDIC insurance within applicable limits. Bank-issued stablecoins would also be protected by the comprehensive regulatory regime banks are subject to, including risk management standards set by a federal bank regulator.
Despite the expectations of some commenters, no new SEC or CFTC authorities or specific initiatives were asserted or announced in the Report. Neither does the report recommend any new bank chartering authority for the OCC. The primary recommendations of the PWG and the Agencies are for new legislation to address the risks posed by stablecoins. However, in the current political environment, the likelihood of new legislation on stablecoins being enacted is fairly low. What is more likely is regulatory agency action, which in the short term may take the form of guidelines and interpretative action as well as enforcement initiatives. We anticipate that we may see additional action by regulators shortly.