John Ho and Arushi Goel outline five key takeaways from the FSB’s proposals for regulating crypto assets and so-called global stablecoins.
On 11 October, the Financial Stability Board (FSB) released its recommendations to strengthen international regulation of crypto assets and so-called global stablecoin (GSC) arrangements. The recommendations address risks that crypto assets and GSC arrangements pose to financial stability. Other types of risks posed by these innovations – such as money laundering and terrorism-financing, data privacy, cyber security and consumer protection – are not directly part of the recommendations, and have yet to be adequately addressed.
Referring to the recent turmoil in the crypto asset markets, the FSB emphasized that recent market trends point towards increasing correlation between the crypto asset market and the traditional financial system. This is due to both a tightening of the financial conditions governing these new assets, and the increasing involvement of traditional financial institutions and retail investors in crypto asset-related products.
Stablecoins represent another area with a risk of spilling over into the mainstream economy. They are often seen as the digital native asset that bridges the crypto and traditional financial systems. Stablecoins that are widely used as a means of payment, or store of value, could pose risks to financial stability. In this context, the FSB’s proposals, while still at a consultation stage, are an important development. They seek to provide regulatory clarity, ensuring that crypto and stablecoin innovations do not put the wider financial system at risk.
FSB’s recommendations for regulating crypto assets
The five key takeaways from the FSB’s proposals are as follows:
1. The principle of “same activity, same risk, same regulation”
The FSB has recommended that crypto assets should be regulated in a similar manner to any other kind of asset. This is an attempt to stop traditional financial activities migrating to less regulated crypto asset markets. The proposed rules also protect consumers and investors, and are proportionate to the risk presented by crypto assets, in terms of their size, complexity and systemic importance.
2. Regulatory powers, cooperation and coordination
The FSB recommends that authorities should have the appropriate powers, tools and resources to regulate, supervise, and oversee crypto asset activities and markets. It also recommends that authorities should cooperate and coordinate with each other, both domestically and internationally. Authorities should use existing information-sharing arrangements (such as supervisory colleges, fora, networks, memoranda of understanding or other ad-hoc arrangements) or establish new arrangements. Information may be shared:
– to facilitate shared understanding of risks and activities of crypto assets and their intermediaries;
– on a timely basis in case of an adverse situation that may have a wider systemic impact on the financial system; and
– regarding enforcement actions against activities operating in multiple jurisdictions.
3. Governance and risk management framework
The FSB recommends that crypto asset issuers and service providers should be obliged to establish robust governance frameworks. These should include:
– clear and direct lines of responsibility and accountability for the functions and activities they are conducting;
– clear definitions of roles and responsibilities of the management body and the decision making process; and
– procedures for identifying, addressing and managing conflicts of interest.
They also need to have effective risk management frameworks that comprehensively address all material risks associated with their activities. This includes adequate resources, policies to prevent money laundering and the financing of terrorism, and effective contingency plans.
The FSB also recommends that authorities should require crypto asset issuers and service providers to have appropriate data management systems. They should provide full and accurate disclosure related to their operations, transactions and risks related to their products. They should take measures to mitigate these risks in an understandable manner. The risk management framework should be proportionate to the risk, size, complexity, and systemic importance of their products, and to the risk that they may pose to the wider economy.
4. Comprehensive regulation and separation of activities
Crypto asset service providers often engage in a wide range of functions, such as custody, brokerage, lending, deposit gathering, market making, settlement and clearing, issuance distribution and promotion. This resembles the activities of a financial conglomerate. The FSB makes clear that this combination of multiple functions may result in complex risk profiles, as well as conflicts of interest.
Existing market regulations can be applied to mitigate conflicts of interest and investor risks arising from the combination of services and functions. Existing prudential regulation seeks to address the corresponding risks, segregate particular functions and ensure they are resilient. The FSB recommends that this should also be the case for those dealing with crypto assets.
5. Higher standards for global stablecoin arrangements
The FSB has agreed on ten high-level recommendations for the regulation, supervision and oversight of global stablecoin arrangements, both at the domestic and international level. A GSC is a stablecoin that enters the mainstream financial system and is widely used in multiple countries. In the absence of adequate regulation, it could pose significant risks to financial stability. Those who issue GCSs need to conform to high regulatory and transparency standards; for example, upholding redemption rights for stablecoin holders, having an effective stabilisation mechanism and maintaining reserves to ensure stability of value.
GSC arrangements are expected to adhere to all applicable regulatory standards, and to address risks to financial stability before commencing operation, and to adapt to new regulatory requirements as necessary.
A first step
The FSB’s proposed recommendations are a significant first step towards the effective regulation of crypto assets. As the various stakeholders discuss and deliberate, it remains to be seen how they will be adopted, implemented and enforced at the domestic and international level. The Forum’s Digital Currency Governance Consortium, composed of more than 80 organizations, recently released a report on the Macroeconomic Impacts of Cryptocurrency and Stablecoins. It is also examining how to regulate crypto assets through multi-stakeholder consultations, with a view towards developing a global approach while addressing local needs.
This article was first published on the World Economic Forum website by John Ho, Head of Legal and Financial Markets at Standard Chartered Bank, and Arushi Goel, Specialist on Data Policy and Blockchain at the World Economic Forum.