[co-author: John Lightbourne]

On June 8, 2022, the New York State Department of Financial Services (“NYDFS”) released industry guidance applicable to U.S. dollar-backed stablecoins issued by NYDFS-regulated entities (the “Guidance”). The Guidance focuses on NYDFS requirements relating to the redeemability of these stablecoins, the asset reserves that back them (the “Reserves”), and auditor examination and attestations regarding management’s assertions concerning the sufficiency of the Reserves.

By way of background, a stablecoin is a type of digital asset that is intended to maintain a stable value, either through the use of an algorithm or because the stablecoin is backed by, and redeemable for, another asset (e.g., U.S. dollars) at a pegged value. The purpose of the peg is to help the coin maintain a stable trading value, thereby increasing its ability to serve as a medium of exchange. Stablecoins can take various forms, and the digital asset marketplace includes a broad range of stablecoins with different structures, purposes, redemption mechanisms, and regulatory oversight. Recently, stablecoins such as Terra’s algorithmic stablecoin (UST) and Tether’s stablecoin (USDT) have made headlines for departing from their pegged value, raising consumer protection concerns from regulators and shaking market confidence in the use of stablecoins.

In issuing this Guidance, NYDFS is, in part, assuaging concerns regarding the stability of stablecoins by reassuring consumers and industry participants that NYDFS-regulated virtual currency licensees and limited purpose trust companies are subject to prudential regulation and appropriate rules and regulations exist which address the issues other stablecoins have experienced such as de-pegging or otherwise deteriorating confidence in the stability of a stablecoin. The requirements imposed in the Guidance are largely consistent with NYDFS’s previous regulatory framework for stablecoin programs. However, the Guidance does adopt a slightly more conservative approach, as demonstrated by the additional requirements for auditor attestations concerning the sufficiency of Reserves and related internal controls, as well as the stricter limits on the investment of Reserve assets in money-market funds.

NYDFS-regulated firms must come into compliance with the Guidance’s requirements by September 8, 2022, except that firms will have a “reasonable period as determined by” NYDFS to comply with the requirements on internal control attestations. We have outlined the Guidance’s requirements, at a summary level, below.

Backing and redeemability

• Stablecoins must be fully backed by a Reserve, such that the market value of the Reserve is at least equal to the nominal value of all outstanding units of the stablecoin as of the end of each business day.
• Stablecoin issuers (“Issuers”) must adopt clear, conspicuous redemption policies approved by NYDFS that confer on the stablecoin holder the right to redeem units of a stablecoin in a timely fashion at a 1:1 exchange rate for the U.S. dollar (net of fees). A “timely” redemption generally means within two business days after the business day on which the issuer receives a redemption order.

Reserve assets

• The Reserve must be segregated from the Issuer’s proprietary assets and held in either a FDIC-insured depository institution or other NYDFS-approved custodian for the benefit of the stablecoin holders.
• The Reserve can only consist of: (1) U.S. Treasury bills acquired three months or less from their respective maturities; (2) Tri-party or bilateral reverse repurchase agreements fully collateralized by U.S. Treasury bills, U.S. Treasury notes and/or U.S. Treasury bonds on an overnight basis; (3) Government money-market funds, subject to NYDFS-approved caps on the fraction of Reserve assets held in such funds and NYDFS-imposed restrictions on the funds, such as minimum allocation requirements; and (4) Deposit accounts at U.S. state or federally chartered depository institutions.
• Although NYDFS Superintendent Adrienne’s Harris’ statement accompanying the Guidance stated that Reserves could only consist of the instruments noted in (1), (2) and (4) in the immediately preceding bullet, Section 2(b)(ii) of the Guidance still permits firms to invest Reserves in government money-market funds. However, the Guidance suggests additional NYDFS-imposed restrictions on investments in such funds, such as approved caps on the fraction of Reserve assets invested and NYDFS-imposed restrictions on the funds themselves.

Attestations

• Management’s assertions regarding the Reserve must be subject to monthly examination by a U.S. -licensed Certified Public Account (“CPA”) applying the attestation standards of the American Institute of Certified Public Accountants. The Guidance includes specific attestations that the CPA’s report must make, including that all NYDFS-imposed restrictions on the Reserve have been met. The Issuer must make these reports available to the public, and produce a copy to the NYDFS, within 30 days after the end of the period covered by the report.
• The Issuer must also obtain an annual report made by an independent U.S.-licensed CPA, which applies the AICPA’s standards in attesting to management’s assertions concerning the effectiveness of the Issuer’s internal controls and procedures for complying with NYDFS-imposed restrictions on the Reserves. The Issuer must provide a copy of the annual attestation report available to the NYDFS within 120 days after the end of the period covered by the report.

In addition to the above, there have been several recent developments in the regulatory space regarding digital assets over the past couple of months. We will continue to monitor and report on significant developments in this space.