Financial Stability Supervisory Board Digital Assets Report

On October 3, 2022, the Financial Stability Oversight Council (“FSOC” or “Board”) released a report outlining the risks posed by digital assets to financial stability in the United States. The FSOC is responsible for identifying emerging threats to financial stability and is composed of the heads of each major federal financial regulator, chaired by the Secretary of the Treasury. The FSOC’s initial position in 2015 was that digital assets generally do not pose a significant risk to financial stability due to limited use and a lack of ties to the traditional financial system. President Biden asked the FSOC to reconsider its position in its “Executive Order on Ensuring Responsible Development of Digital Assets.”

The FSOC report partly reaffirmed its 2015 position by concluding that digital assets currently do not pose a great risk to the US financial system. However, the report pointed out that digital assets could pose risks if their interconnection with the traditional financial system or their overall scale increases significantly, without being accompanied by appropriate regulation. The FSOC noted that interconnection with the mainstream financial system remains limited, but the overall scale is growing rapidly.

The FSOC has refrained from advocating for an omnibus federal law regulating digital assets, as some members of Congress have advocated. Instead, the report concluded that existing regulations already cover the vast majority of the digital asset space. To that end, the FSOC has simply published a list of recommendations advising regulators how to better oversee digital asset activity.

Perhaps more important than the overall findings, the FSOC identified three specific gaps in the current digital asset regulatory framework and made a series of recommendations outlining how to close them. The three gaps identified are:

  • spot markets for non-securities cryptoassets, such as Bitcoin, are subject to limited direct federal regulation;

  • crypto-asset businesses have the ability to engage in regulatory arbitrage due to the fragmented nature of the regulatory system; and

  • the possibility of direct retail access to markets by vertically integrating traditional intermediary services such as brokers, which is not yet a reality in the United States but has been offered by a number of crypto trading platforms -assets.

On the issue of spot markets, the FSOC made an explicit recommendation to Congress to pass legislation granting a federal agency regulatory authority over the spot markets of unsecured cryptoassets. The FSOC has called for broad rule-making, enforcement and review authority in this space. The Board did not make a concrete recommendation as to which federal agency should be granted this authority, but noted that the Commodity Futures Trading Commission (“CFTC”) already has broad authority over derivatives trading in unsecured crypto-assets, just not spot markets.

When it comes to regulatory arbitrage, the FSOC has divided its list of concerns into two categories of entities: issuers of stablecoins, which tie the value of cryptoassets to a benchmark, such as the US dollar; and crypto-asset platforms. In both of these cases, the FSOC is concerned that companies may not be able to take advantage of the fact that no single regulator has a complete overview of the entire company or its relationships. Thus, companies may be able to engage in regulatory arbitrage by underestimating the risks that the whole company bears or by simply having different subsidiaries report to different regulators. The FSOC report made four specific recommendations to address this risk:

  • first, that Congress pass comprehensive legislation specifically for stablecoin issuers;

  • second, that Congress pass legislation granting regulators the power to oversee affiliates and subsidiaries of crypto-asset entities;

  • third, a generic recommendation that regulators coordinate between agencies in these spaces; and

  • fourth, a call for banking regulators to use their existing powers in the area of ​​crypto-assets.

The FSOC has not made any specific recommendations or calls to action regarding the possibility of vertical integration granting retailers direct (sometimes called “non-intermediary”) access to digital asset markets. Instead, the matter was simply flagged for future consideration by member agencies.

Finally, the FSOC called for a whole-of-government approach to data collection in the area of ​​crypto-assets to better understand potential risks to financial stability, and for member agencies to continue to develop their expertise in digital assets.

Copyright © 2022, Hunter Andrews Kurth LLP. All rights reserved.National Law Review, Volume XII, Number 279

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