Regulation
Does the latest cryptocurrency law represent an opportunity for banks to circumvent regulation?
Rep. Maxine Waters, a California Democrat and ranking member of the House Financial Services Committee, said a Republican-led cryptocurrency bill could open the door for financial firms to evade Securities and Exchange Commission oversight. Photographer: Andrew Harrer/Bloomberg
Andrew Harrer/Bloomberg
WASHINGTON-A cryptocurrency bill passed by an unusually wide bipartisan margin in the House it could create a loophole for traditional financial companies – including banks – to bypass tougher regulation.
Last month the House voted to pass a bill establishing a regulatory regime for cryptocurrencies, and the bill passed with unusual bipartisan support. Seventy-one Democrats voted for the bill, including senior party members such as former House Speaker Rep. Nancy Pelosi of California.
The bill faces tougher odds in the Senate, where Senate Banking Committee Chairman Sherrod Brown, D-Ohio, has been skeptical of cryptocurrency legislation that he sees as too favorable to the cryptocurrency industry.
But the House vote was a turning point for cryptocurrencies in Washington, as more and more Democratic lawmakers appear to be interested in considering some sort of bill. Senate Majority Leader Chuck Schumer, D-N.Y., along with a group of mostly Northeast and West Coast Democrats, are growing friendlier toward a narrow set of crypto issues, creating an opportunity for the cryptocurrency industry and Republicans to find common ground and pass a bill establishing a regulatory regime for the industry.
A number of Democratic senators, including Schumer, voted in favor of the Congressional Review Act’s challenge to SEC Staff Accounting Bulletin 121, which banks claim effectively reduces their ability to store cryptocurrency. Although Biden vetoed this challenge on Friday, the bill that recently passed the House would have a very similar effect, preventing the SEC from making rules or issuing guidelines that would prevent banks from entering the cryptocurrency custody business.
Looking ahead, a key element of the upcoming debate on the cryptocurrency law, known as the “Financial Innovation and Technology for the 21st Century Act” or FIT21, will be the implications of the law not only on cryptocurrencies, but also on traditional financial institutions. including banks.
Some House Democratic members argued that the bill could make it easier for banks — typically larger banks with consolidated trading desks — and asset managers to create assets that would be overseen by the Commodity and Futures Trading Commission rather than the Securities and Exchange Commission, which is generally considered to have a lighter regulatory touch.
Specifically, much of the concern centers on a section titled “Clarity for Assets Offered as Part of an Investment Contract.” House Democrats argued that this section was added only in the most recent iteration of the legislation and after the bill passed through the House Financial Services Committee’s markup.
“Language was added to the bill after it was flagged by the jurisdiction committees to also allow some traditional titles to exist even in this regulatory no man’s land,” said Rep. Maxine Waters, D-Calif., on the House plan.
The section outlines the ways in which a “contractual investment asset” – normally something that would fall under the purview of the SEC – would not be regulated by the SEC if it meets certain decentralization criteria, including whether the asset transaction is registered on a cryptographically protected media. public register.
Graham Steele, a fellow at the Roosevelt Institute and until recently assistant secretary for financial institutions at the Treasury Department, said that under the bill, banks and other financial institutions could set up a blockchain system, outsource that operation or spin-in-out, and then anything listed on that platform would be outside the scope of SEC regulation.
“There are ways you could get a bank to support a blockchain network,” he said. “Any person can self-certify to the SEC that the network and related digital assets are decentralized. And then, assuming the SEC… doesn’t dispute that, they move into the digital commodities space and have CFTC oversight.”
The risk of larger institutional players entering this market is twofold, Steele said. The CFTC requires less information and offers consumers less protection than the SEC, which could result in harm to consumers, while the entry of large, traditional companies could create financial bubbles that threaten financial stability.
“So there is the micro-consumer harm caused by investing in products and services and not necessarily having all the information to understand the risks,” he said. “And then, number two, you could have large financial institutions in charge making these markets bigger and bigger, which could turn this into a financial stability issue.”
Lee Reiners, a professor at Duke Law who studies fintech and cryptocurrency policy, said that, in theory, a large nonbank financial firm like BlackRock, which already has a tokenized fund, could make some changes to that offering to meet the design’s definition of law. of what can be classified as goods. Reiners, along with numerous financial law academics and consumer groups, wrote to both the House Financial Services Committee outlining these concerns for lawmakers.
“If you give Wall Street the opportunity to game the system and go for a lighter regulatory regime, they will,” he said. “You can imagine someone saying, ‘OK, if you don’t want to register with the SEC, just put it on the blockchain.’”
Republicans, meanwhile, argue that their bill does not pose this dilemma. Rep. French Hill, R-Ark., a lead sponsor of the legislation, said the bill specifically defines assets offered as part of an investment contract as securities, unless they are otherwise defined as securities. This is part of a complex legal criterion called Howey’s test established by a 1946 Supreme Court case.
“The minority has repeatedly charged that somehow with this bill a great securities loophole is being offered and opened,” he said. “That’s not really true, it’s just not a factual statement.”
Hill said the term “investment contract” is a “fungible digital representation” and that the bill specifically defines digital assets as not including notes, stocks, Treasury securities and security-based swaps.
“So it doesn’t open the loophole that makes the ranking member of the Financial Services Committee pay,” he said.
This assessment has also gained traction among other experts. Zachary Zweihorn, a partner at Davis Polk, said the idea that financial institutions “can simply slap a blockchain label on something” and then opt out of the securities regulatory framework is “unrealistic under the text of the bill.” .
“The way I read it, it says that an asset sold under an investment contract is not automatically a security,” said Zachary Zweihorn, a partner at Davis Polk. “Unless it’s a security, which is kind of a circular.”
If a large bank or other financial institution were to create an asset that meets the definition of a digital asset that would be regulated by the CFTC under the Republicans’ cryptocurrency bill, Zweihorn said the CFTC might be the best place to regulate that asset .
“It is difficult to imagine a bank creating this type of business that meets this definition,” he said. “And you know, if they do, it’s probably not the worst idea for it to end [to the CFTC].”