US lawmakers edge closer to rules for stablecoins

US lawmakers moved closer to a bipartisan agreement on new legislation that would regulate so-called stablecoins as part of efforts to impose basic safeguards on volatile cryptocurrency markets.

The potential deal would mark the first significant step to apply tougher rules on an industry that developed with virtually no regulation. Biden administration officials and a bipartisan group of lawmakers worry that current laws don’t provide comprehensive standards for the new assets and have warned of potential risks to financial stability posed by stablecoins, a type of cryptocurrency intended to be pegged to the dollar or another national currency.

Those anxieties have grown in recent months after tether, the largest stablecoin, briefly lost its peg during the collapse in May of terraUSD, a so-called algorithmic stablecoin that was backed by another cryptocurrency rather than cash or safe assets.

“Investors are getting hurt now and eventually this market could become systemic, which is why they need to establish some oversight now,” said Sheila Bair, a former chair of the Federal Deposit Insurance. “Nobody has clear jurisdiction and that’s why Congress would ideally move ahead. ”

The potential deal to introduce the legislation hinges on negotiations between House Financial Services Committee chair Maxine Waters and Patrick McHenry, the top Republican on the panel. The deal wasn’t yet final and could still fall apart, people familiar with the negotiations said.

Asked on 20 July if she had reached an agreement with McHenry, Waters said “we’re working on it”, in a brief interview. McHenry, in a separate interview, said he is close to a deal, but that it wasn’t done yet.

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If a deal is reached in the coming days, the legislation could be voted on by Waters’s panel as early as next week, and pass the House in the coming weeks or months, people familiar with the matter say. It faces an uncertain path in the Senate.

Policymakers worry that stablecoins could be vulnerable to mass withdrawals by investors if doubts emerge about their ability to continue redeeming their tokens at a one-to-one ratio for official currencies. That could force a scramble by stablecoin issuers to liquidate their reserves, putting downward pressure on asset prices and potentially damaging broader financial markets.

In addition, stablecoin issuers maintain thinner cushions against eventual losses than banks. This raises the possibility that issuers would need to dip into the reserves that back their tokens, potentially undermining the tokens’ value.

The debate in Washington over how to regulate stablecoins has focused on whether the vehicles should be treated more similarly to banks or to money-market mutual funds. Banks face a tougher supervision regime that includes requirements to hold significant capital buffers to absorb any losses. Money -market funds, overseen by the Securities and Exchange Commission, are subject to extensive disclosure obligations and must comply with specific rules that say which types of safe assets they can hold.

The bill being considered by Waters and McHenry leans toward treating stablecoin issuers more like banks, the people said, requiring the issuers to comply with federal supervision as well as capital and liquidity rules.

It would also authorise stringent requirements for the assets used to back a stablecoin, moves that supporters say will reduce the risks of destabilising fire sales of those assets in a crisis to meet requests from investors.

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In crafting the legislation, supporters appear to have favoured the Federal Reserve over the SEC. Some officials familiar with the talks said that stems at least in part from concerns that the SEC has a shaky record in tackling financial stability risks posed by investments that promise a stable value. Over a 12-year period, the Fed twice had to intervene to support money funds during crises.

The SEC is concerned that the bill may not sufficiently address the trading of stablecoins once they are issued, another person familiar with the matter said. Recent versions of the bill didn’t provide regulators authority to police fraud or market manipulation, or give them a window into the trading platforms where most stablecoin transactions take place.

Previous versions of the legislation included language that would have more-explicitly preserved the authority of the SEC and other market regulators to police the industry, one of the people said.

An SEC spokesperson declined to comment.

Another provision of the bill would commission the Fed to study a so-called central bank digital currency, or a US digital dollar, backed by the central bank. The Fed is in the early stages of considering the idea, which Fed vice-chair Lael Brainard has said could one day provide consumers with a level of safety amid a proliferation of privately-issued stable coins.

In the Senate, Ohio Senator Sherrod Brown, a Democrat who chairs the chamber’s banking committee, hasn’t been deeply involved in the legislation’s negotiations, the people said. Brown has held hearings on the topic and in February said that the US needs a ” strong, proactive approach from regulators and Congress to limit stablecoins’ risks for working Americans. ”

“Senator Brown is continuing to evaluate proposals from his colleagues in Congress to determine if they will sufficiently protect Americans’ hard-earned money and our economy from the risks of digital assets,” said a spokeswoman for the Ohio lawmaker.

Even if the legislation falls short of becoming law this year, it could provide momentum headed into the new Congress next year. McHenry is expected to take over as chairman of the financial services committee should GOP lawmakers take over the House after the midterm elections in November ..

Waters and McHenry’s bill was expected to envision a prominent role for the Federal Reserve as the regulator of the issuers of “payment stablecoins,” the people said. The restrictions proposed by the bill include prohibiting non-financial companies from issuing the products. The move seeks to impose stricter separations between financial firms and commercial businesses or technology firms — such as Meta Platforms’ Facebook — that have pushed for larger roles in finance.

Stablecoin issuers, such as Tether and Circle Internet Financial, seek to maintain a steady value for their tokens by investing customers’ assets in cash or high-quality assets such as short-term Treasury securities.

But there is little regulatory oversight over how these so-called reserves are managed.

Siobhan Hughes contributed to this article.

Write to Andrew Ackerman at [email protected] and Paul Kiernan at [email protected]

This article was published by The Wall Street Journal, part of Dow Jones

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