By Matthew Homer and Paul Watkins
The President’s Working Group Report on Stablecoins is an important first step for federal regulators to develop a regulatory approach. Unfortunately, the report is a slap in the face to state regulators as it ignores their years of regulatory experience. The Report rests on the assumption that stablecoins are unregulated. This opinion appears widely shared in Washington DC, and has been expressed by Federal Reserve Chairman Powell, Treasury Secretary Yellen, and SEC Chair Gensler. In commenting on the Report the Acting Comptroller of the OCC, Michael Hsu, describes stablecoins as an “unregulated means to engaging in speculative asset trading, lending, and borrowing,” concluding that these products “need federal prudential supervision to grow and evolve safely.”
In fact, stablecoins are regulated by the states and have been for some time. We have worked for both federal and state regulators, and the presence of state and federal regulatory structures is a strength to our financial system. This dual approach should have served as the foundation for the Report’s recommendations. Instead, the report reads like a federal power-grab over the future of finance.
The Report was hamstrung from the beginning because no state regulator was included, even though a state banking commissioner is part of FSOC. Apparently, the Conference of State Banking Supervisors was not even consulted, as they are not listed on the Report’s annex. This leads to glaring oversights, such as the complete absence of any discussion of existing state regulation.
Had states been involved, the Report likely would have analyzed some of the following facts. Several stablecoins have been issued under the supervision of the New York state financial regulator (which traces its roots to the oldest bank regulatory agency in the country), including Gemini Dollar and Pax Dollar. The issuers of these coins hold trust charters granted under New York banking law and are subject to a comprehensive supervision regime.This includes the same type of requirements that exist for other trust companies, such as capital reserves, examinations, and compliance with anti-money laundering rules.
Additionally, for stablecoins in particular, there are restrictions on what issuers may do with the assets they hold in reserve in order to ensure they are fully exchangeable for a U.S. dollar. Monitoring and recordkeeping requirements also exist, such as the monthly independent audits published by these firms. Ask any company who has received approval from the New York State Department of Financial Services, and they will tell you the process is far from “unregulated.”
Some states have designed other regulatory structures. For example, Wyoming has established a Special Purpose Depository Institution focused on banking-related activities, such as custody and fiduciary asset management. Nebraska has adopted similar legislation, Illinois may do the same. Other states continue to thoughtfully put forward regulatory solutions to this new financial product.
With respect to stablecoins, states have highly relevant expertise and experience because they are the primary regulators with the responsibility for licensing and supervising money transmission activity. Stored value products offered by state-licensed money transmitters like PayPal have similarities to stablecoins. They too take dollars from customers and hold that value in liquid investments. The fact that PayPal is not regulated as a money market fund does not mean that PayPal is unregulated. It’s unclear if the report’s recommendations would also sweep up these type of payments companies.
Acknowledging these existing regulatory structures should have been a prerequisite to reaching the conclusion that all stablecoin issuers be “insured depository institutions.” [p.2] No doubt there is a role for insured depositories to participate, but the existing state-based system that includes non-depositories should not be rejected without discussion. If carried out, the report’s recommendations would serve to make the banking industry even more powerful than it is currently. Instead policymakers should see stablecoins as an opportunity to challenge the existing power structures that dominate financial services.
Regulatory structures for stablecoins will no doubt evolve. Real risks exist, as evidenced by the CFTC’s recent enforcement action against Tether. However, federal regulators can address these risks without preempting state regulatory structures, or stifling needed payments innovation. As in the dual-banking system, federal charters can develop as an alternative to state-based charters or other authorization.
State and federal regulators have historically both contributed to financial regulation. Particularly with respect to a rapidly developing area like stablecoins, the presence of state and federal regulatory approaches is essential to ensuring innovation can develop.
Although the state experience does not appear in the Report, our hope is that FSOC and Congress will acknowledge and work alongside this existing state framework. As federal officials consider their approach to stablecoins, they can learn from the regulatory approaches already taken by states like New York, Wyoming, and others.
Matthew Homer is Executive in Residence at Nyca Partners, a fintech venture capital firm, and was previously Executive Deputy Superintendent at the New York State Department of Financial Services and a Policy Analyst at the FDIC. Paul Watkins is Managing Director at Potomak Global Partners, a financial services consultancy, and previously founded the CFPB’s Office of Innovation, and led the Civil Litigation Division of the Arizona Attorney General’s Office.
The original op-ed appeared in RealClearMarkets on November 3, 2021 and can be found here.