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Congress Urged to “Act Promptly” on Stablecoin Regulation

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A long-awaited report from the President’s Working Group on Financial Markets (PWG) was released this week, urging Congress to swiftly address concerns about the regulation of stablecoins. The PWG also outlines what a legislative framework for stablecoins could look like based on current regulatory gaps.

Treasury Secretary Janet Yellen argued: “Stablecoins that are well-designed and subject to appropriate oversight has the potential to support beneficial payments options. But the absence of appropriate oversight presents risks to users and the broader system.”

“Current oversight is inconsistent and fragmented, with some stablecoins effectively falling outside the regulatory perimeter.”

The PWG, which includes the Treasury, the Federal Reserve Board (FRB), the Securities and Exchange Commission (SEC), and the Commodity Futures Trading Commission (CFTC), was created to strengthen US financial markets. It was convened in July to assess risks associated with the stablecoin market, which has grown by around 500% in the past 12 months, with a current market capitalization of around $140bn.

Regulators are betting that stablecoins will be one of the major virtual asset typologies to enter everyday usage as a payment vehicle for households and businesses. The PWG, Financial Action Task Force (FATF), and others fear this would increase the potential for destabilizing runs, disruptions in the payment system, and the ability of criminals to leverage stablecoins to move illicit funds.

A legislative framework for stablecoins

The report recommends that Congress should establish an appropriate federal framework for stablecoin regulation that complements the oversight exercised by existing authorities with respect to market integrity, investor protection, and illicit finance. It should cover multiple areas, and include standards for issuers, wallets, and other key service providers. Legislation should address three key sets of concerns:

  1. User protection and run risk: Require stablecoin issuers to be insured depository institutions that are subject to appropriate supervision and regulation, at the depository institution and the holding company level.
  2. Payment System Risk: Require custodial wallet providers to be subject to appropriate federal oversight. In addition, provide the supervisor of a stablecoin issuer with authority to require any entity that performs activities critical to the functioning of the stablecoin arrangement to meet appropriate risk-management standards.
  3. Systemic Risk and Concentration of Economic Power: Require stablecoin issuers to comply with activities restrictions that limit affiliation with commercial entities. Supervisors should also have the authority to implement standards to promote interoperability among stablecoins. Limits on custodial wallet providers’ affiliation with commercial entities or on custodial wallet providers’ use of user transaction data may also help address these issues.

The report notes that because stablecoins are an emerging and rapidly developing type of financial asset, legislation should provide regulators with the flexibility to respond to future developments and adequately address risks across a variety of organizational structures.

Interim measures to be taken while Congress decides how to act include enforcement of Bank Secrecy Act (BSA) obligations by FinCEN, and the designation of certain activities conducted using stablecoin as systemically important payment, clearing, and settlement (PCS) activities.

International cooperation emphasized 

The PWG report also showed that the federal government believes international cooperation on standards to be crucial in tackling AML/CFT risks.

“A critical factor for illicit finance risk mitigation, regardless of the features of a stablecoin’s design, is that international standards for the regulation and supervision of service providers associated with stablecoins and other digital assets are effectively implemented worldwide,” the report says.

It adds that a lack of AML/CFT enforcement globally is leading to gaps in the regulation and supervision of stablecoins and enabling digital funds to be used to launder money, store the proceeds of crime, or evade sanctions; and supports new guidance from the FATF regarding the implementation of standards for VAs and VASPs.

Tougher enforcement action expected

The report also highlights the need for an enhanced supervisory role by FinCEN and the Internal Revenue Service (IRS) – who have been examining convertible virtual currency (CVC) compliance since 2014. This could lead to better private sector compliance and tougher enforcement.

“Enforcement activity would signal to stablecoin administrators and other financial institutions in the stablecoin industry that they will be held accountable for failing to meet AML/CFT and sanctions obligations, will incentivize compliance and may enhance pressure on some foreign jurisdictions to follow suit,” the report states.

For compliance teams, the “illicit finance risk” section of the report is essential reading. In this section, the PWG indicates that stablecoin transactions could be treated as “money transmission services,” subjecting them to Bank Secrecy Act obligations and FinCEN regulation.

Firms should also look out for forthcoming National Risk Assessments on money laundering, terrorist financing, proliferation financing, and illicit finance strategies that are mentioned in the report.

The PWG report is the latest in a recent string of announcements by federal bodies, including sanctions guidance for the virtual currency industry issues by OFAC and analysis of ransomware-related SAR filings by FinCEN.

Originally published November 22, 2021, updated May 6, 2022

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