During the past few months, the US Treasury, the US banking agencies, the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) have pursued several regulatory or enforcement initiatives relating to firms engaging in stablecoin activities. This report summarizes some of the key initiatives of those US federal regulators. Part I of the report covers the “Report on Stablecoins” (PWG Report) issued on November 1, 2021, by the President’s Working Group on Financial Markets (PWG), together with the Federal Deposit Insurance Corporation (FDIC) and the Office of the Comptroller of the Currency (OCC).1 Parts II and III highlight certain stablecoin-related enforcement activities of the SEC and the CFTC, respectively. Part IV summarizes guidance issued by the OCC on November 18, 2021, relating to certain cryptocurrency, distributed ledger and stablecoin activities.
- PWG Report on stablecoins
On November 1, 2021, the PWG, together with the FDIC and the OCC, published the PWG Report. The PWG is chaired by the Secretary of the Treasury and includes the Chair of the Board of Governors of the Federal Reserve System (FRB), the Chair of the SEC, and the Chair of the CFTC, or their designees (the agencies comprising the PWG, together with the FDIC and the OCC, are referred to in this report collectively as the Agencies). The Agencies believe that legislation is “urgently needed to comprehensively address the prudential risks”2 posed by payment stablecoins and recommended that Congress “act promptly to enact legislation to ensure that payment stablecoins and payment stablecoin arrangements are subject to a federal prudential framework on a consistent and comprehensive basis.”3 The publication of the PWG Report occurred during a year in which the stablecoin supply grew approximately 523%, from $29.06 billion as of January 1, 2021, to $152.12 billion as of January 1, 2022.4
The PWG Report analyzes prudential risks posed by stablecoins used as a means of payment and provides prudential framework recommendations for addressing those risks. The “prudential recommendations apply to ‘payment stablecoins,’ defined as those stablecoins that are designed to maintain a stable value relative to a fiat currency and, therefore, have the potential to be used as a widespread means of payment.”5
The Agencies made specific recommendations to Congress with respect to (i) stablecoin issuers, (ii) stablecoin custodial wallet providers and (iii) other entities that perform activities that are critical to the functioning of the stablecoin arrangement. The Agencies also made clear that pending action by Congress, the Agencies are committed to taking action to address risks falling within each Agency’s jurisdiction.6
If Congress were to enact legislation consistent with the Agencies’ recommendations,
- a stablecoin issuer7 would be required to be an insured depository institution (IDI) subject to the regulatory, supervisory and examination authority of a US federal banking agency – either the OCC, the FRB or the FDIC,
- stablecoin issuers would be subject to the consolidated supervision and examination authority of the FRB at the holding company level and to activities restrictions that limit affiliation with commercial entities and
- federal oversight of stablecoin custodial wallet providers would include authority to restrict wallet providers from lending customer stablecoins, and to require compliance with appropriate risk-management, liquidity and capital requirements.
In addition, with respect to custodial wallet providers, the Agencies recommended that Congress consider limits on affiliation with commercial entities or on use of users’ transaction data.
The recommendations of the Agencies to Congress are summarized in Section I.A below. Section I.B summarizes the Agencies’ recommendations to the Financial Stability Oversight Council (Council). We note that the PWG Report also highlighted some of the US Treasury’s efforts to mitigate illicit finance risk and indicated that Treasury will continue leading efforts on the Financial Action Task Force to encourage countries to implement international standards with respect to anti-money laundering (AML)/countering the financing of terrorism (CFT) and pursue additional resources to support supervision of domestic AML/CFT regulations.8
- Recommendations to Congress
Recommendations applicable to stablecoin issuers
According to the PWG Report, the failure of a stablecoin to perform as expected would harm the users of that stablecoin and could result in a “run”on that stablecoin. Accordingly, legislation applicable to stablecoin issuers “should provide for supervision [of stablecoin issuers] on a consolidated basis; prudential standards; and, potentially, access to appropriate components of the federal safety net.9 To accomplish these objectives, legislation should limit stablecoin issuance, and related activities of redemption and maintenance of reserve assets, to entities that are insured depository institutions.”10 The proposal to require that stablecoin issuers be limited to IDIs may reflect that the financial stability risks of a stablecoin run figured prominently among the risks of stablecoins that have the potential to be used as a widespread means of payment.
“Legislation should also ensure that supervisors have authority to implement standards to promote interoperability among stablecoins.”11
Recommendations applicable to stablecoin custodial wallet providers
“To address concerns about payment system risk, legislation should require custodial wallet providers to be subject to appropriate federal oversight.”12 Such oversight should include authority to restrict wallet providers from lending customer stablecoins, and to require compliance with appropriate risk-management, liquidity and capital requirements.
The Agencies also recommended that Congress consider other standards for custodial wallet providers, such as limits on affiliation with commercial entities or on use of users’ transaction data.13 These measures, according to the Agencies, would address concerns about concentration of economic power.
As mentioned, the Agencies believe that limits on affiliation with commercial entities should apply to stablecoin issuers and that such limits on affiliation may also be appropriate with respect to stablecoin wallet providers. In this context, the Agencies explained three potential policy concerns resulting from the potential for an individual stablecoin to scale rapidly:
- The failure or distress of a stablecoin issuer or a wallet provider or other key participant in a stablecoin arrangement could adversely affect financial stability and the real economy.14
- The combination of a stablecoin issuer or wallet provider and a commercial firm could lead to an excessive concentration of economic power.15
- “[A] stablecoin that becomes widely adopted as a means of payment could present concerns about anti-competitive effects, for example, if users of that stablecoin face undue frictions or costs in the event they choose to switch to other payment products or services.”16
According to the Agencies, the first two policy concerns “are analogous to those traditionally associated with the mixing of banking and commerce, such as advantages in accessing credit or using data to market or restrict access to products.”17
Entities that perform activities that are critical to the functioning of the stablecoin arrangement
The Agencies recommended that Congress provide the federal supervisor of a stablecoin issuer – i.e., the OCC, the FRB or the FDIC – with the authority to require any entity that performs activities critical to the functioning of the stablecoin arrangement to meet appropriate risk-management standards. The Agencies suggested that the Principles for Financial Market Infrastructures,18 as adapted to stablecoin arrangements, would be appropriate risk-management standards. According to the PWG Report, “legislation should also provide appropriate agencies with examination and enforcement authority with respect to the stablecoin activities of these entities.”19 The PWG Report acknowledged the limitations of the OCC’s, FRB’s and FDIC’s current regulatory and examination authority over third-party service providers,20 indicating that “[i]n the context of stablecoins, the ability to apply existing authority to regulate and examine stablecoin-related services provided by non-bank service providers might be dependent on the structure of the relationship and the nature of the services provided to the individual client banks.”
- Recommendations to Financial Stability Oversight Council
The Agencies recommended that if Congress does not act, the Council should consider steps available to it to address the risks outlined in the PWG Report. The Council can be expected to show interest in the potential financial stability consequences of the stablecoin run risks highlighted in the PWG Report, particularly if stablecoin supply continues its rapid growth trajectory or a stablecoin issuer or custodial wallet provider scales rapidly. “Such steps may include the designation of certain activities conducted within stablecoin arrangements as, or as likely to become, systemically important payment, clearing, and settlement (PCS) activities. Designation would permit the appropriate agency to establish risk-management standards for financial institutions that engage in designated PCS activities, including requirements in relation to the assets backing the stablecoin, requirements related to the operation of the stablecoin arrangement, and other prudential standards.”21 Such financial institutions would be subject to “an examination and enforcement framework.”22
- Certain SEC developments
Stablecoins are used to facilitate trading, borrowing and lending on digital asset trading platforms and in decentralized finance (DeFi) arrangements. Digital asset trading platforms and DeFi arrangements present investor risks of particular focus to the SEC to the extent they involve securities under US federal securities laws. According to a November 9, 2021, statement by SEC Commissioner Caroline Crenshaw, a variety of DeFi participants, activities and assets fall within the SEC’s jurisdiction, as they involve securities and securities-related conduct, but no DeFi participants within the SEC’s jurisdiction have yet registered with the SEC.23
One focus of the SEC’s enforcement actions has been DeFi arrangements. For example, according to Coinbase,24 it received from the SEC last summer a Wells Notice related to its crypto lending program called Lend. In response to allegations made by the SEC, Coinbase revised its plans to launch the program.
The SEC also recently settled an enforcement action with a DeFi platform and its two individual promoters. The SEC alleged they failed to register their offering, which raised $30 million, and misled investors.25 The SEC’s action resulted in disgorgement of $12.8 million and penalties of $125,000 each for the two individuals.
It is expected that the SEC will continue to bring enforcement actions against digital asset trading platforms and DeFi arrangements that engage in unregistered offerings of securities.
- CFTC’s Tether Order
The CFTC has regulatory authority over the trading of derivatives (swaps, futures, options on futures, and commodity options) on a broad range of underlying or reference assets, except for certain securities-related derivatives that are jointly regulated by the CFTC and the SEC, and other securities-related derivatives that are regulated by the SEC alone.
The CFTC also has anti-fraud and anti-manipulation enforcement authority with respect to the sale of commodities in the US cash markets.11 Specifically, Commodity Exchange Act (CEA) Section 6(c)(1)26 broadly prohibits any person, directly or indirectly, from using or employing, or attempting to use or employ, in connection with any contract of sale of any commodity in interstate commerce, any manipulative or deceptive device in contravention of any CFTC rule. CFTC Rule 180.127 prohibits “intentionally or recklessly … mak[ing] any untrue or misleading statement of a material fact or … omit[ting] to state a material fact necessary in order to make the statements made not untrue or misleading” in connection with any swap or with a contract of sale of any commodity in interstate commerce, or for future delivery on or subject to the rules of any registered entity.
On October 15, 2021, the CFTC issued an enforcement order against Tether Holdings Limited and certain of its affiliates (Tether), issuers of a US dollar tether token (USDt).28 The CFTC ordered Tether to cease and desist from violating Section 6(c)(1) of the CEA and Regulation 180.1(a)(2) and to pay a $41 million civil monetary penalty. In particular, the CFTC claimed that Tether had intentionally or recklessly made untrue or misleading statements of material facts and omissions of material facts, including representations that Tether would fully back USDt with fiat currency in accounts held in Tether’s own name; omissions regarding the actual backing of USDt including non-fiat assets, such as commercial paper; representations that Tether would undergo regular professional audits; and omissions regarding the pre- disclosed timing of one of the two reviews that Tether did undertake.
In the Tether Order, the CFTC made clear its view that the USDt, “a virtual currency stablecoin, is a commodity and subject to applicable provisions of the [CEA] and Regulations.”29 The CFTC is apparently staking its claim to anti-fraud and anti-manipulation enforcement authority over at least some cash market transactions involving virtual currency stablecoins.
SEC Chair Gary Gensler, only one month prior to the issuance of the Tether Order, had mentioned in a Senate Banking Committee hearing on September 14, 2021, that stablecoins “may well be securities” under US securities laws. The CFTC’s and the SEC’s both asserting authority over different stablecoin activities is a reminder that the activities in which a stablecoin issuer, wallet provider or intermediary engages may give rise to compliance obligations under the federal securities laws and the CEA – as well as US banking laws, the Bank Secrecy Act/AML/CFT rules and consumer protection laws.
- OCC Interpretive Letter 1179
On November 18, 2021, the OCC issued Interpretive Letter 1179, which clarifies the circumstances under which national banks and federal savings associations (Banks) may engage in certain cryptocurrency, distributed ledger and stablecoin activities.30 Interpretive Letter 1179 makes clear that the cryptocurrency activities addressed in three prior interpretive letters issued in 2020 and 2021 (Prior Interpretive Letters) “are legally permissible for a Bank to engage in, provided the Bank can demonstrate, to the satisfaction of its supervisory office, that it has controls in place to conduct the activity in a safe and sound manner.”31
The OCC indicated that Interpretive Letter 1179 was being issued “as a result of the OCC’s review of interpretive letters regarding cryptocurrencies and digital assets.”32 The Prior Interpretive Letters comprise the following:
- OCC Interpretive Letter 1170, addressing whether Banks may provide cryptocurrency custody services
- OCC Interpretive Letter 1172, addressing whether Banks may hold dollar deposits serving as reserves backing stablecoin in certain circumstances
- OCC Interpretive Letter 1174, addressing whether Banks may (1) act as nodes on an independent node verification network (i.e., distributed ledger) to verify customer payments and (2) engage in certain stablecoin activities to facilitate payment transactions on a distributed ledger33
Before commencing any of the activities addressed in the Prior Interpretive Letters, a Bank should provide written notice to its supervisory office of its intention to engage in the relevant activities and should not engage in those activities until it receives written notification of the supervisory office’s non-objection.34 After a Bank has received supervisory non-objection, the OCC will review those activities as part of its ordinary supervisory processes.35
To obtain supervisory non-objection, the Bank will need to demonstrate to the OCC that it has established “an appropriate risk management and measurement process for the proposed activities, including having adequate systems in place to identify, measure, monitor, and control the risks of its activities, including the ability to do so on an ongoing basis.”36 In this connection, the OCC mentioned that the Bank’s proposal must specifically address the risks relating to the cryptocurrency activities the Bank proposes to conduct, including operational risk, liquidity risk, strategic risk and compliance risk (including but not limited to compliance with the Bank Secrecy Act, AML, sanctions requirements and consumer protection laws).37
With respect to compliance risk, the Bank will need to demonstrate that its compliance management system will be sufficient and appropriate to ensure compliance with all applicable laws. In particular, to address compliance, the Bank “should demonstrate, in writing, an understanding of any compliance obligations related to the specific activities the Bank intends to conduct, including, but not limited to, any applicable requirements under the federal securities laws, the Bank Secrecy Act, AML, the Commodity Exchange Act, and consumer protection laws.”38
Banks already engaged in cryptocurrency, distributed ledger or stablecoin activities as of November 18, 2021, do not need to obtain supervisory non-objection. However, the OCC expects that such a Bank will have provided notice to its supervisory office and the OCC will examine these activities as part of its ongoing supervisory process.
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1 President’s Working Group on Financial Markets, Federal Deposit Insurance Corporation and Office of the Comptroller of the Currency, “Report on Stablecoins,” US Department of the Treasury (November 2021), available at https://home.treasury.gov/system/files/136/StableCoinReport_Nov1_508.pdf.
2 PWG Report, p. 18.
3 PWG Report, p. 2.
4 Source: Total Stablecoin Supply, The Block, available at https://www.theblockcrypto.com/data/decentralized-finance/stablecoins/total-stablecoin-supply-daily.
5 PWG Report, p. 2.
6 PWG Report, p. 3.
7 Stablecoin issuers would comprise issuers “that are domiciled in the United States, offer products that are accessible to U.S. persons, or that otherwise have a significant U.S. nexus.” PWG Report, p. 16, fn. 29.
8 PWG Report, p. 19.
9 PWG Report, p. 2.
10 PWG Report, p. 16.
11 PWG Report, p. 16.
12 PWG Report, p. 2.
13 PWG Report, p. 17.
14 PWG Report, p. 14.
15 PWG Report, p. 14.
16 PWG Report, p. 14.
17 PWG Report, p. 14.
18 See Committee on Payment and Settlement Systems and the Technical Committee of the International Organization of Securities Commissions, Principles for financial market infrastructures (Bank for International Settlements, April 2012), https://www.bis.org/cpmi/publ/d101a.pdf.
19 PWG Report, p. 17.
20 PWG Report, p. 15, fn. 27.
21 PWG Report, p. 18.
22 PWG Report, p. 18.
23 Commissioner Caroline A. Crenshaw, “Statement on DeFi Risks, Regulations, and Opportunities” (Nov. 9, 2021), https://www.sec.gov/news/statement/crenshaw-defi-20211109.
24 https://blog.coinbase.com/the-sec-has-told-us-it-wants-to-sue-us-over-lend-we-have-no-idea-why-a3a1b6507009.
25 See Blockchain Credit Partners d/b/a DeFi Money Market, Gregory Keough, and Derek Acree, Order Instituting Cease and Desist Proceedings, Securities Act Release No. 10961 (Aug. 6, 2021).
26 7 U.S.C. § 9(1) (2018).
27 17 C.F.R. § 180.1(a)(2) (2020).
28Tether Holdings Limited et al., CFTC Docket No. 22-04 (Oct. 15, 2021) (Tether Order), available at https://www.cftc.gov/media/6646/enftetherholdingsorder101521/download.
29 Tether Order, p. 8.
30 Interpretive Letter 1179 also addresses the authority of the OCC to charter a national trust bank, which is not discussed here.
31 Interpretive Letter 1179, p. 1.
32 Interpretive Letter 1179, p. 1, fn. 2.
33 Interpretive Letter 1179, p. 1.
34 Interpretive Letter 1179, p. 1.
35 Interpretive Letter 1179, p. 4.
36 Interpretive Letter 1179, p. 4.
37 Interpretive Letter 1179, p. 4.
38 Interpretive Letter 1179, p. 4.
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