The global central bank cooperative body envisions stablecoins within the context of international standards for payment, clearing, and settlement systems.

By Alan W. Avery, Stuart Davis, Simon Hawkins, Stephen P. Wink, Pia Naib, and Deric Behar

Among the different types of digital assets, global authorities seem most focused on stablecoins.

This concern is the result of a few factors:

–Stablecoin use has ballooned in a very short time, going from less than US$3 billion in market capitalization at the beginning of 2019 to approximately US$130 billion as of October 2021.

–Stablecoins are intimately connected with the financial system because they function as an intermediary between traditional markets and cryptoasset markets.

–Stablecoin arrangements are in many cases opaque regarding the nature of the asset reserves underlying their currency peg.

–Stablecoins remain mostly unregulated.

Understanding and containing the systemic risks in this burgeoning asset class is therefore a top priority for regulators worldwide.

The BIS Report

On October 6, 2021, the Bank for International Settlements (BIS) Committee on Payments and Market Infrastructures (CPMI) and the International Organization of Securities Commissions (IOSCO) published a joint report and consultation on the regulation of stablecoin arrangements titled “Application of the Principles for Financial Market Infrastructures to stablecoin arrangements” (the BIS Report).

The BIS Report does not offer new standards, but instead provides clarifying guidance on how the Principles for Financial Market Infrastructures (PFMI) apply to systemically important stablecoin arrangements. The PFMI, as defined by BIS, are a set of 24 key international standards that the BIS issued for financial market infrastructures (i.e., payment systems, central securities depositories, securities settlement systems, central counterparties, and trade repositories) to strengthen and preserve financial stability.

While recognizing stablecoins as a novel digital asset, the BIS Report asserts that they should be regulated as financial market infrastructure similar to traditional payment, clearing, and settlement systems. Since stablecoin arrangements “are primarily used for making payments, the principles that apply to payment systems … will apply in their entirety to stablecoin arrangements performing a transfer function based on a functional approach (‘same business, same risks or risk profile, same rules’).”

The BIS Report is structured around four of the 24 PFMI principles: governance, comprehensive risk management, settlement finality, and money settlements. Following these four principles, a systematically important stablecoin arrangement should:

  • Employ appropriate governance, including clear documentation and disclosures of management structures, control, lines of accountability, operations, and affiliations
  • Develop appropriate risk management and mitigation frameworks and tools to address material risks (e.g., legal, credit, liquidity, operational, and other risks) that it bears and poses to customers and affiliated entities (“institutional interdependencies”)
  • Provide clear and final settlement (regardless of the operational settlement method used), and manage risks arising from a misalignment between technical and legal finality
  • Minimize and strictly control the credit and liquidity risk arising from the use of non-central bank money

Further, non-central bank money employed as a settlement asset must be readily convertible into central bank money or other liquid assets in both normal and stressed circumstances. Stablecoin arrangements must also monitor, mitigate, and manage “run risks” associated with large-scale redemptions and “fire sales” of reserve assets, with potentially systemic implications. Stablecoin arrangements must custody and invest assets in a way that minimizes the risk of loss on and delay in access to those assets.

Responses to the consultation prompts are due by December 1, 2021.

The Road Ahead for Stablecoin Oversight

On October 7, 2021, the Financial Stability Board (FSB) published a progress report describing the level of adoption by global regulatory bodies of its high-level recommendations for supervising global stablecoin that were published in October 2020. Such recommendations included increased regulator coordination and oversight of stablecoin arrangements to ensure that governance and risk management frameworks are in place to minimize systemic risks. The progress report noted that uptake of the recommendations was at an “early stage,” but the FSB tacitly urged global authorities to move faster on collaboration, implementation, and cooperation to address systemic risks and prevent “regulatory arbitrage and harmful market fragmentation.”

According to the announcement accompanying the BIS Report, “[e]ach jurisdiction retains the prerogative to determine within its own context whether to allow stablecoin activity. If it does so, and if a stablecoin arrangement is systemic or is likely to become systemic, then the PFMI (supplemented by the report’s guidance) would also apply.”

A US Treasury Department-led presidential advisory group is studying the potential impact of stablecoins on the US financial system and is expected to release its findings soon. Whether a US regulatory approach would integrate the BIS or FSB recommendations remains to be seen. However, the US’s methods of oversight and prescriptions for risk management will likely share similarities with those of global supervisory authorities, to the extent that stablecoins are seen as a systemic risk.