House Financial Services Committee Hearing

On May 18th, the House Financial Services Committee Subcommittee on Digital Assets, Financial Technology, and Inclusion held a hearing entitled “Putting the ‘Stable’ in ‘Stablecoins:’ How Legislation Will Help Stablecoins Achieve Their Promise.”  Witnesses in the hearing were:

• Fennie Wang, Founder and CEO, Humanity Cash 

• Matt Homer, Former Executive Deputy Superintendent of Research and Innovation, New York Department of Financial Services (NYDFS) 

• David Portilla, Partner, Davis Polk & Wardwell 

• Robert Morgan, CEO, USDF Consortium 

• Delicia Reynolds Hand, Director of Financial Fairness, Consumer Reports 

The following is a summary of the main topics explored in today’s hearing prepared by Delta Strategy Group.   

• The key focus of the hearing was the two stablecoin draft bills recently released by Committee Republicans and Democrats.  Both bills are based off of bipartisan efforts last Congress between Committee Chairman Patrick McHenry (R-NC) and Ranking Member Maxine Waters (D-CA) last Congress to create stablecoin legislation, but they now contain some differences.
  • Both bills would allow banks and non-banks to apply to be stablecoin issuers, require stablecoin issuers to maintain 1:1 reserves of cash or cash equivalents for all issued stablecoins, mandate regular audits, and mandate timely and orderly withdrawals of all customer assets.
  • The bipartisan stablecoin draft legislation released last Congress included sections that would impose a two-year moratorium on algorithmic stablecoins and mandate further reports on the creation of a central bank digital currency (CBDC).  The new Democrat draft keeps these sections, but the new Republican bill no longer includes them.
  • The two bills take a different approach to dividing federal and state regulation of stablecoins.  The Republican version of the bill creates a federal regulatory floor but maintains strong authority for states to continue regulating stablecoin issuers.  The Democrat version however grants the Federal Reserve (Fed) preemptive authority to veto all applications for stablecoin issuers and makes it the primary regulator for issuers.  The Democrat version also prohibits non-bank issuers from accessing fed programs like payment systems and discount windows.
  • The Democrat version of the bill mandates that the Fed consider issues like diversity and financial inclusion when considering issuer applications whereas the Republican bill would limit considerations for an application to its ability to meet reserve requirements, its governance structure, and risks the stablecoin might pose to investors.
• Despite these differences, Subcommittee Chairman French Hill (R-AR) said that the bills are substantially similar in their goal of creating a regulatory framework for stablecoin operations.  He noted that the Committee has found success in bipartisan negotiations on this issue in the past.

Republican Draft: H.R. ____, To provide for the regulation of payment stablecoins, and for other purposes 

Democrat Draft: H.R. ____, To provide requirements for payment stablecoin issuers, research on a digital dollar, and for other purposes. 

Subcommittee Chairman French Hill (R-AR) 

We had productive bipartisan discussions on effective guideposts for stablecoin legislation which we turned into the stablecoin proposal last Congress.  Any legislation must have strict reserves requirements to guard against runs.  The only way that stablecoins can become an effective means of payment is through creating an appropriate regulatory framework through legislation.   

We are actively working on these issues in a bipartisan way, and we are not starting from scratch.  Committee Ranking Member Maxine Waters’ (D-CA) stablecoin draft is substantially similar to the draft released last Congress except for three changes, one of which is the same as a change we made in our latest draft.  Without Congressional action, opaque, offshore projects will continue to thrive. 

Subcommittee Ranking Member Stephen Lynch (D-MA) 

We almost reached a bipartisan agreement on stablecoins last Congress.  While the bill was far from perfect, we had come to an agreement on some key issues.  Since then, the digital asset space has collapsed, and recent bank failures taught us important lessons.  Future legislation must address what we have learned.  We need to find alignment between the Republican and Democrat drafts we are currently considering.   

My concern is that stablecoins are not truly used for payments.  Instead, they are primarily used as tools to engage with speculative assets.  Non-bank stablecoin issuers should not have access to Fed services and master accounts.  I am also concerned about custody and the lack of acknowledgement that the Securities and Exchange Commission (SEC) is the primary regulator of stablecoins along with the Consumer Financial Protection Bureau (CFPB).  Rep. Waters’ (D-CA) bill includes specific rules that requires issuers to protect assets they custody and prevents comingling of assets.  We must also address the issue of state-level regulation because this could cause a race to the bottom. 

Fennie Wang, Founder and CEO, Humanity Cash 

We believe that there is a significant opportunity to harness the technology of stablecoins to encourage strong local banking and capital formation.  Community banks see stablecoins as an innovative deposit-gathering tools and see blockchain technology as replacing core banking infrastructure in the future. 

Matt Homer, Former Executive Deputy Superintendent of Research and Innovation, New York Department of Financial Services (NYDFS) 

New York’s experience shows that it is possible to regulate stablecoins using common sense regulatory practices.  New York regulation includes three major prongs that must be found in all regulation: reserve requirements to ensure that the assets backing stablecoins are held on a segregated basis, fully reserved on a 1:1 basis, and are comprised of cash or cash equivalents; redemption rights ensuring that stablecoin users can redeem stablecoins on a 1:1 basis in a timely manner; and public transparency requirements including monthly attestations from third-parties. 

Stablecoin legislation should recognize the dual banking system as an inherent feature of the American economy that benefits consumers and the American economy.  Legislative drafts preserve this dynamic by allowing states to create tougher rules than federal regulation if they prefer.  Legislation should also promote competition by creating clear pathways for new companies to challenge major incumbents.  Considering competitiveness should be a statutory requirements for regulators when they are determining whether to license an issuer. 

David Portilla, Partner, Davis Polk & Wardwell 

The current legal framework is ill-suited to comprehensively regulate payment stablecoins.  Legislation that enables fit-for-purpose regulation would help foster an environment for this technology to scale.  Stablecoin issuers must accept more stringent regulatory oversight, and, in exchange, a more tailored regulatory framework should be couples with appropriately calibrated privileges from the government.   

Legislation must allow non-banks to issue stablecoins.  There should be options to be regulated directly at the federal level or primarily at the state level with an overlay of federal oversight.  Granting non-bank stablecoin issuers access to Fed payment systems and discount window could help them provide more efficient service to their customers, and Congress should considering allowing this but limit access in both scale and scope.  Congress must also consider whether or not stablecoins should have access to federal insurance, and this should turn on the nature of the assets that back them.  Securities laws should not be applied to payment stablecoins.  

Robert Morgan, CEO, USDF Consortium 

Hill (R-AR):  Is there technology for stablecoin issuers to provide intraday evaluations of their reserves?  How do we balance state and federal regulations for stablecoins?  Homer:  Yes, this technology is available.  Stablecoin issuers should have to be totally transparent on the number of stablecoins they issue and their reserves.  Both the state and federal regulatory systems have benefits and drawbacks.  State regulators are closer to the ground and know constituents better, but federal regulations create clarity.  A strong federal floor ensures that a race to the bottom is not possible. 

Lynch (D-MA):  The fact that most stablecoins are not registered in stricter jurisdictions like New York shows that there already is a race to the bottom.  Should we give stablecoin issuers access to Fed services in light of the failures we have seen?  Hand:  We should not start there.  Maybe we could consider this down the line once we have cut down on rampant fraud and abuse. 

Davidson (R-OH):  How has de-banking this industry created a lack of stability?  Could a regulated stablecoin experience a traditional bank run?  Could stablecoins improve American markets by creating a demand for U.S. treasuries?  Homer:  It has become much more difficult for companies in this space to have banking services.  This will lead companies to deposit their money offshore.  Under this proposal, I do not see how any stablecoin could go to zero without fraud;  Portilla:  If stablecoin issuers were required to hold Treasuries, it would create more demand. 

Foster (D-IL):  Should issuers require a Fed attestation that it holds appropriate assets before minting new tokens?  Can you create digital identities without compromising privacy?  Homer:  Attestations could benefit investor confidence;  Wang:  There is a way to create KYC identifications without making identities clear on the blockchain.  This allows you to freeze compromised tokens in the case of criminal actions. 

Rose (R-TN):  The Waters draft of this legislation includes several disastrous aspects including requiring stablecoin issuers to disclose diversity information that has no relevance to their financial creation.  It also pushes us further towards a CBDC which would be the greatest assault on financial privacy since the Bank Secrecy Act.  Does information on diversity and financial inclusion have anything to do with the safety of a stablecoin?  Portilla:  The safety and soundness factors in this legislation are different from community benefit standards.  These standards seem to be taken from banking law, which really is not relevant to stablecoins. 

Rose (R-TN):  If we are going to use blockchain technology for payments, is it essential to have a more stable token than bitcoin or ether to use for payments?  Morgan:  This is an essential piece of ensuring that cryptocurrency technology create real world value.  Tokenized deposits are an important way to harness this technology. 

Sherman (D-CA):  We should ban all cryptocurrencies including stablecoins. 

Steil (R-WI):  What can we learn from foreign regulatory frameworks?  A key aspect of the Howey test is an expectation of profit.  Could the purchaser of a stablecoin have the expectation of profit?  Homer:  Stablecoin frameworks in jurisdictions like the EU and Singapore differ slightly by creating a tiering system based on the size of stablecoin operations.  There is no expectation of profit for a user of a stablecoin, and stablecoins are not securities. 

Waters (D-CA):  Should the Fed be able to reject state-level regulations?  What are the dangers of comingling funds?  Hand:  Yes, the Fed should have overarching authority over all state regulations.  Custodial structures protect consumer funds.  If a firm goes bankrupt, there must be a clear pathway to the recovery of customer funds. 

Timmons (R-SC):  Would there be a role for the Fed to play under Committee Chairman McHenry (R-NC) bill?  What are the differences in these two bills in the factors that regulators may or may not consider when approving a stablecoin issuer?  Homer:  There would be a significant role for the Fed to play, and it could step in if it felt companies were not properly regulated.  The factors in the McHenry bill include financial stability and fitness of management as well as risks and benefits.  The more subjective factors in the Waters draft could make it more difficult to understand how to put together an application, and it creates significant discretion on why the Fed could reject an application.  The McHenry bill would create more clarity and transparency. 

Nickel (D-NC):  How can stablecoins promote the dominance of the U.S. dollar?  How can we maintain a strong federal floor for stablecoins while also allowing state level regulations?    Homer:  We are seeing a transformation of money from analog to digital, and stablecoins can be the most significant tool to ensure that the dollar remains dominant through this transition.  This is vital to ensure that we can use sanctions to accomplish security goals.  We should look to the EU and Singapore when understanding how to tier our regulation of stablecoins.  Congress should consider creating a threshold for when companies become valuable enough to need Fed regulations. 

Flood (R-NE):  Why is a state route to regulatory compliance critical for stablecoins?  Could this create a race to the bottom?  Wang:  We would not be able to have grassroots innovators without a state path to regulatory compliance.  Under the McHenry bill, companies would still have to meet a federal floor, but there is no reason to preempt state regulation;  Homer:  The McHenry bill creates a federal floor that is essentially the current New York standard for stablecoin regulation, so it is hard to imagine how there could be a race to the bottom.  

Torres (D-NY):  Why should there be a strong state option for fractional reserve banking but not for stablecoins?  Homer:  There is no rational argument for this.