On July 13, 2022, the Committee on Payments and Market Infrastructures (“CPMI”) and the International Organization of Securities Commissions (“IOSCO”) finalized guidance on the application of the Principles for Financial Market Infrastructures (“PFMIs”) to systemically important stablecoin arrangements (“Stablecoin Guidance”).1 This guidance is intended to help national regulators and stablecoin arrangements comply with the PFMIs while taking into account the novel features of stablecoins.
In this Legal Update, we provide background on the PFMIs and discuss some key points from the Stablecoin Guidance.
The 2008 financial crisis resulted in increased attention being paid to the important role of multilateral systems that provide the infrastructure for transferring, clearing, and settling payments, securities, and other financial transactions, commonly known as financial market utilities or financial market infrastructures (“FMIs”).2 In particular, policymakers recognized that the failure or a disruption to the functioning of systemically important FMIs could create, or increase, the risk of significant liquidity or credit problems spreading among financial institutions or markets and thereby threaten the stability of the financial system.
Globally, CPMI and IOSCO developed international standards in 2012 to strengthen and preserve the financial stability of systemically important FMIs. These standards are the PFMIs and combined sector-specific approaches into a universal set of principles. In addition to the substantive risk management, governance, and financial requirements of the PFMIs, systemically important FMIs are required to make certain public disclosures of standardized information about their rules and compliance activities.
In the United States, Congress adopted Title VIII of the Dodd-Frank Act, which authorized the Financial Stability Oversight Council (“FSOC”) to designate certain FMIs as systemically important.3 Currently, there are eight such FMIs in the United States, and they are subject to enhanced regulation by the relevant US financial regulators (e.g., Regulation HH for FMIs regulated by the Federal Reserve Board).4 The US regulators broadly apply the PFMIs when supervising US systemically important FMIs.5
The Stablecoin Guidance applies to stablecoin arrangements that are considered systemically important FMIs, including legal entities that are integral to such arrangements (collectively, SI-SAs).6 Such arrangements explicitly include systemically important arrangements that transfer coins (such as a payment system) but may also include arrangements that more closely resemble other types of FMIs. For determining the systemic importance of a stablecoin arrangement, the Stablecoin Guidance provides factors for national regulators to use in conducting a holistic assessment of each arrangement (e.g., size, risk profile, interconnectedness, substitutability).
The Stablecoin Guidance describes how certain PFMIs should be applied to SI-SAs, specifically focusing on governance (Principle 2), comprehensive management of risks (Principle 3), settlement finality (Principle 8), and money settlements (Principle 9).7 For example, the Stablecoin Guidance discusses the importance of maintaining appropriate governance mechanisms at SI-SAs, including mechanisms that allow for timely human intervention and assignment of ultimate responsibility and accountability to natural persons. The Stablecoin Guidance notes that stablecoin arrangements may perform non-FMI functions and operate in connection with non-FMI entities, and, therefore, SI-SAs need to be particularly aware of the risks from multiple interdependent functions, distributed/automated protocols, and decentralized operations and governance.
An interesting point in the Stablecoin Guidance is that CPMI and IOSCO criticize the “probabilistic” nature of many cryptocurrency settlement processes. They note that many distributed ledger technologies reduce the probability of revocation of a transaction by having multiple nodes validate the transaction and subsequent transactions. However, a transaction may always remain subject to revocation through certain consensus mechanisms, forks, or other governance interventions. This potential revocation in conformance with the rules (i.e., code) of the stablecoin arrangement would violate the PFMI that a transaction should achieve legal finality at the time of settlement.
The Stablecoin Guidance is not intended to create new requirements for SI-SAs but highlights the potentially significant gaps between the PFMIs and current market practices for stablecoins. For example, some stablecoin arrangements may eschew human intervention in favor of “code is law” principles. As national regulators take a closer look at stablecoins, SI-SAs may need to consider modifications to their governance and risk management practices.
Further, many national regulators have not addressed stablecoin arrangements in a systematic manner. For example, FSOC has not designated any stablecoin arrangements as SI-SAs nor have US regulators explicitly sought to impose the PFMIs on any stablecoin arrangements. We expect to see the PFMIs, as informed by the Stablecoin Guidance, figure prominently in the discussion as regulators in the United States and around the globe move toward greater regulation of stablecoins.
1 Press Release, CPMI and IOSCO publish final guidance on stablecoin arrangements confirming application of Principles for Financial Market Infrastructures (July 13, 2022), https://www.bis.org/press/p220713.htm.