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US Banking Regulator Issues Guidance on Banks Holding Stablecoin Reserves

On September 21, 2020, the US federal prudential banking regulator Office of the Comptroller of the Currency (“OCC”) published a letter (the “OCC Guidance”) regarding US federal banks’ and thrifts’ authority to hold funds which function as reserves for stablecoins.

As noted in the OCC Guidance, stablecoins are a type of cryptocurrency backed by another asset such as a fiat currency, commodity, another cryptocurrency, or other assets “with values that are pegged to a fiat currency or managed by algorithm”. The OCC Guidance specifically focuses on stablecoins which are “backed by a single fiat currency and redeemable by the holder of the stablecoin on a 1:1 basis”. The OCC Guidance only addresses transactions in which stablecoins are held in a hosted wallet and not an un-hosted or personal wallet held by the owner of a stablecoin.

The OCC Guidance noted that issuers of stablecoins often place funds with a bank which back the stablecoin (“reserve funds”), the most basic example being a stablecoin issuer placing its reserve funds in a deposit account with a national bank. These issuers often promote these reserve funds and the fact that they are held by banks to bolster the trustworthiness of their stablecoin.

The OCC Guidance states that US national banks may provide permissible banking services to cryptocurrency businesses, including stablecoin issuers, as long as both the bank and the issuer manage the risks of cryptocurrency and comply with applicable laws, particularly those related to the Bank Secrecy Act (“BSA”), regulations dealing with anti-money laundering, and applicable securities laws. For example, banks holding deposit reserves for stablecoins must ensure they have the proper procedures in place to comply with laws and regulations relating to deposit insurance coverage, customer due diligence requirements under the BSA and the customer identification requirements under the USA PATRIOT Act. Banks must also ensure they identify and verify the beneficial owners of legal entity customers opening accounts. In order to address liquidity risks associated with reserve funds, the OCC recommends that banks should have procedures in place to verify daily that the reserve funds held by the bank for the stablecoin issuer are always equal to or greater than the number of the issuer’s outstanding stablecoins. Overall, the OCC recommends that banks should establish appropriate risk management processes for new activities before entering into any agreement or relationship with a stablecoin issuer, and all new bank activities should align with the bank’s overall business plan and strategies.

Canadian Perspective

In Canada, similar specific guidance has not yet been issued. Canada previously participated in the G7 Working Group on Stablecoins which issued a report on the impact of global stablecoins in 2017, outlining potential public policy risks and challenges. In addition, in 2019, the Basel Committee on Banking Supervision, which Canada is a member of, issued a statement on crypto-assets together with a discussion paper on designing a prudential treatment for crypto-assets, noting that a bank should adopt the following minimal requirements when acquiring crypto-asset exposure or providing related services, which could include acting as a custodian or taking deposits from a reserve backing crypto-assets:

  • Due diligence – Banks should conduct comprehensive analysis of risks before engaging in crypto-asset related services.
  • Governance and risk management - Banks “should have a clear and robust risk management framework that is appropriate for the risks of its crypto-asset […] services”.
  • Disclosure - “A bank should publicly disclose any material crypto-asset exposures or related services as part of its regular financial disclosures and specify the accounting treatment for such exposures, consistent with domestic laws and regulations.”
  • Supervisory dialogue – “The bank should inform its supervisory authority of actual and planned crypto-asset activity in a timely manner and provide assurance that it has fully assessed the permissibility of the activity and the risks associated with the intended exposures and services, and how it has mitigated these risks.”

Furthermore, the Financial Stability Board, which Canada is also a member of, issued a report earlier in 2020 (the “FSB Report”) providing recommendations with respect to global stablecoins and related cryptoassets, noting in particular that regulatory authorities should ensure that global stablecoin arrangements “have effective risk management frameworks in place especially with regard to reserve management, operational resiliency, cyber security safeguards and [anti-money laundering/counter-terrorist financing] measures, as well as ‘fit and proper’ requirements.” The FSB Report notes the following international guidance and standards relevant to banks providing custody for reserve assets for global stablecoin arrangements:

  • the Financial Action Task Force (FATF) standards applicable to those who provide “safekeeping and administration of cash and liquid securities on behalf of other persons” or “safekeeping and/or administration of virtual assets or instruments enabling control over virtual assets”;
  • the Basel Framework and Principles for the sound management of operational risk;
  • the International Organization of Securities Commissions (IOSCO) Recommendations Regarding the Protection of Client Assets; and
  • where applicable, the Principles for Financial Market Infrastructures (PFMIs), including in particular the principles with respect to custody and investment risks and transparency.

While the FSB Report focused on global stablecoins, the above international standards and guidance (and Canadian regulation reflecting such standards guidance) would also be relevant to consider in the general context of Canadian financial institutions (such as trust companies) wishing to provide custody for reserve assets for stablecoins. In addition, any Canadian regulated financial institution considering offering any services relating to stablecoins or to issuers thereof should first discuss such plans with their prudential regulator.

In addition with the above international guidance, the points raised by the OCC in the OCC Guidance are also relevant in the Canadian context, in particular the need to comply with applicable laws such as the Proceeds of Crime (Money Laundering) and Terrorist Financing Act (Canada) and applicable securities laws, and the need to establish appropriate risk management processes for new activities before entering into any agreement or relationship with a stablecoin issuer.

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