Stablecoin regulation is one of my perennial favourite topics. Yes I know – I need to get out more but getting this stuff right does truly matter. I have gone down this particular rabbit hole more than a couple of times already. This has partly been about the question of how much we can rely on existing disclosure regarding reserves (here and here for example ) but the bigger issue (I think) is to determine what is the right regulatory model that ensures a level playing field with existing participants in the provision of payment services while still allowing scope for innovation and competition.
JP Koning has been a reliable source of comment and insight on the questions posed above (see here and here for example). Dan Awrey also wrote an interesting paper on the topic (covered here) which argues that the a state based regulatory model (such as the money transmitter licensing regime) is not the answer. There is another strand of commentary that focuses on the lessons to be learned from the Free Banking Era of the 19th century, most notably Gorton and Zhang’s paper titled “Taming Wildcat Stablecoins” which I covered here.
Although not always stated explicitly, the focus of regulatory interest has largely been confined to “payment stablecoins” and that particular variation is the focus of this post. At the risk of over-simplifying, the trend of stablecoin regulation appears to have been leaning towards some kind of banking regulation model. This was the model favoured in the “Report on Stablecoins” published in November 2021 by the President’s Working Group on Financial Markets (PWG). I flagged at the time (here and here) that the Report did not appear to have a considered the option of allowing stablecoin issuers to structure themselves as 100% reserve banks (aka “narrow banks”).
Against that background, it has been interesting to see that United States Senator Toomey (a member of the Senate Banking Committee) has introduced a discussion draft for a bill to provide a regulatory framework for payment stablecoins that does envisage a 100% reserve model for regulation. Before diving into some of the detail, it has to be said that the bill does pass the first test in that it has a good acronym (Stablecoin TRUST Act where TRUST is short for “Transparency of Reserves and Uniform Safe Transactions”.
There is not a lot of detail that I can find so let me just list some questions:
- The reserve requirements must be 100% High Quality Liquid Assets (HQLA) which by definition are low return so that will put pressure on the issuer’s business model which relies on this income to cover expenses. I am not familiar with the details of the US system but assume the HQLA definition adopted in the Act is the same as that applied to the Liquidity Coverage Ratio (LCR) for depositary institutions.
- Capital requirements are very low (at most 6 months operating expenses) based I assume on the premise that HQLA have no risk – the obvious question here is how does this compare to the operational risk capital that a regulated depositary institution would be required to hold for the same kind of payment services business activity
- Stablecoin payment issuers do not appear to be required to meet a Leverage Ratio requirement such as that applied to depositary institutions. That might be ok (given the low risk of HQLA) subject to the other questions about capital posed above being addressed and not watered down in the interests of making the payment stablecoin business model profitable.
- However, in the interest of a level playing field, I assume that depositary institutions that wanted to set up a payment stablecoin subsidiary would not be disadvantaged by the Leverage Ratio being applied on a consolidated basis?
None of the questions posed above should be construed to suggest that I am anti stablecoins or financial innovation. A business model that may be found to rely on a regulatory arbitrage is however an obvious concern and I can’t find anything that addresses the questions I have posed. I am perfectly happy to stand corrected but it would have been useful to see this bill supported by an analysis that compared the proposed liquidity and capital requirements to the existing requirements applied to:
- Prime money market funds
- Payment service providers
- Deposit taking institutions
Let me know what I am missing
Tony – From the Outside
Note – this post was revised on 14 April 2022
- The question posed about haircuts applied to HQLA for the purposes of calculating the Liquidity Coverage Ratio requirement for banks was removed after a fact check. In my defence I did flag that the question needed to be fact checked. Based on the Australian version of the LCR, it seems that the haircuts are only applied to lower quality forms of liquid assets. The question of haircuts remains relevant for stablecoins like Tether that have higher risk assets in their reserve pool but should not be an issue for payment stablecoins so long as the reserves requirement prescribed by the Stablecoin TRUST Act continues to be based on HQLA criteria.
- While updating the post, I also introduced a question about whether the leverage ratio requirement on depositary institutions might create an un-level playing field since it does not appear to be required of payment stablecoin issuers