Regulation
Backdoor Regulatory Option Haunts US Crypto
After the 2008 global financial crisis, Congress established a roundtable of regulators who could have a unique tool against the next emerging threats. The Financial Stability Oversight Council (FSOC) can label companies with systemic risk labels that impose sweeping new restrictions on them, and the crypto sector is getting the board’s attention.
In November, the FSOC – a group of heads of the US Department of the Treasury, the Federal Reserve, the Securities and Exchange Commission and other agencies – erased some key changes of the Trump era that neutralized the council’s power to designate companies as threats. It has now fully regained its effects, even if the authority has remained dormant for a long time.
At any time, the board could decide that one of the giants in the digital assets industry – say a stablecoin issuer like Circle – could harm the financial system as a whole if it fails, much like American International Group Inc. Its role in the 2008 mortgage meltdown. When the FSOC places this label on a company, it becomes a regulatory arm of the Fed, subject to a number of compliance and oversight requirements.
So far, there is no indication that such a decision is forthcoming, but the council was warned of the emerging dangers of stablecoins for financial stability, and congressional Republicans have finally made this potentially public in a subcommittee hearing this month. While most of the digital assets industry was glued to the news of spot Bitcoin exchange-traded funds (ETFs), lawmakers on the House Financial Services Committee asked pointed questions about what the regulator Uber has exactly in mind for crypto.
“FSOC needs to exercise great caution when considering the idea of circumventing Congress and its intentions,” said Rep. French Hill (R-Ark.), chairman of the Digital Assets Subcommittee, who highlighted legislative work he and other lawmakers pushed crypto bills to the House floor.
“We have developed a regulatory framework for digital assets and a regulatory regime for stablecoins,” he said. “We don’t need FSOC to be involved in this. What they need to do is support our legislative effort.”
The systemic risk watchdog’s most recent mention of virtual assets appeared in its annual report last month, which again highlighted crypto as an emerging potential danger to the health of American finance. Regulators are particularly concerned about stablecoins, tokens matching the value of stable assets such as the U.S. dollar, which are typically used as a way to buy and sell volatile digital assets. On the surface, the council’s calls for crypto legislation appear to support lawmakers’ goals. But the report once again adds a kind of warning. “The council remains prepared to consider measures available to it to address stablecoin risks in the event that comprehensive legislation is not enacted,” it said. Bottom line: if you don’t act quickly, we can.
Despite the warning, one of the witnesses at the hearing, Ji Kim, general counsel and head of global policy at the Crypto Council for Innovation, told CoinDesk that the FSOC is still unlikely to use the tool.
“It would certainly be surprising if this happened, since the FSOC designation deliberately sets the bar very high, which is intended for high-magnitude risks,” he said. Council members acknowledged that the current crypto sector “does not constitute a systemic risk.”
Bill Hulse, senior vice president of the U.S. Chamber of Commerce’s Center for Capital Markets Competitiveness, suggested during the hearing that the board could threaten Congress with potential risk designations to pressure how bills are drafted. But he argued that 2022 – with its massive industry failures, including the collapse of FTX – has clearly demonstrated that there is no evidence that the crypto sector can significantly shake the rest of the financial plumbing of the country.
“None of these failures – including cases of fraud and other abuses of consumer trust – have had a material effect on the ‘traditional financial system,’” he said in his testimony.
The FSOC has a spotty record and is notoriously slow, as a long list of agency heads with very different interests must agree on what actions the board will take. Initially, he used several large insurers, including AIG, but the four companies he initially named have since disappeared. In the years since, it has largely focused on its annual report which flags lingering concerns.
Lawmakers and Paul Kupiec, a senior fellow at the American Enterprise Institute, noted during the hearing that the group of regulators recently failed to avert one of the most severe financial crises since the lending collapse mortgages. When institutions such as Silvergate Bank and Signature Bank began to collapse – in part due to its reliance on crypto industry deposits – the board had done nothing to prevent it.
Federal banking agencies whose heads are part of the FSOC “failed to supervise banks that had significant business relationships with the digital assets industry,” Kupiec noted. “They failed to use their rapid remedial action powers to mitigate risks generated by banks’ investment decisions and digital business relationships.”
To place a crypto company under Fed supervision, the board would have to go through a lengthy, multi-step process that has never been used for companies other than those involved in the dangers of the 2008 crisis. a crypto firm as risky could also make the board wonder why it hasn’t targeted a giant US asset manager.
For now, Republican lawmakers appear to be issuing their own warning that the administration will hear from them again if FSOC goes down this path.