22 April 2020 Michael Voisin  -  Harry Eddis  -  Richard Hay  -  Joshua Ashley Klayman  -  Peiying Chua Heikes  -  Sophia Le Vesconte FintechLinks

The FSB outlines recommendations for regulating global stablecoins as Libra issues revised whitepaper

The Financial Stability Board has presented its recommendations for addressing the risks posed by global stablecoin (GSC) arrangements to the G20, with a new consultation paper. This comes as the Libra Association released a revised whitepaper for its proposed GSC. In this post, we look at what the FSB paper tells us about: (1) GSC design requirements; (2) regulatory gaps; and (3) how GSCs will be supervised across borders.

Recent developments

Over the last year, global authorities have raised serious concerns around the risks posed by GSCs, including the potential impact on global financial stability. These were in part prompted by Libra’s original whitepaper, which officially revealed Facebook’s plans to launch a digital currency. This month we have seen two high profile responses to those concerns:

Recommendations from the FSB

The Financial Stability Board (an international standard-setting agency) has released a consultative document outlining ten high-level recommendations to address the regulatory, supervisory and oversight challenges raised by GSC arrangements. 

This builds on the work of the G7 working group on stablecoins and the International Organization of Securities Commissions (IOSCO), among others. It was presented at a virtual meeting of the G20 Finance Ministers and Central Bank Governors this month. We discuss three key takeaways from this paper below.

Libra 2.0

Meanwhile, the Libra Association has released a revised whitepaper, intended to address the issues previously raised by regulators.

In particular, in response to concerns that Libra could challenge the sovereignty of national currencies, it has introduced a number of single currency stablecoins and proposed that the Libra currency would be a digital composite of some of those coins, rather than a separate digital asset. 

It has also incorporated additional consumer protections. For example, it now envisages that “Designated Dealers” will commit to making markets in its stablecoins and that there will be a built-in mechanism for redemption in case those markets do not materialise.  

Three takeaways from the FSB consultation paper

1. GSC design requirements

A number of the FSB’s recommendations seek to ensure that any GSC arrangement has certain prudential features. Although the report is aimed at regulators, it sends a clear message to developers as to what will be expected.

The paper also reiterates the message that GSC arrangements will need to meet all necessary regulatory requirements before commencing operation. 

The requirements include:

  • A comprehensive governance framework with a clear allocation of accountability. In particular, the report stresses the importance of governance bodies that can shoulder regulatory responsibility and notes that fully permissionless ledgers “may not be suitable” if concerns cannot be addressed. Interestingly, Libra 2.0 is “forgoing the future transition to a permissionless system” according to its new whitepaper.
  • Effective risk management frameworks. This includes requirements around reserve management (including stabilisation mechanisms), operational resiliency, cyber security safeguards and AML/CTF. Libra has clearly focused on these issues too. As well as measures outlined above, it is seeking to build in liquidity and capital protections to strengthen its reserve and to adopt a “robust compliance framework”.
  • Robust data management systems. As well as ensuring the integrity and security of data, GSC arrangements are expected to be built in a manner that affords regulators with appropriate access.
  • Appropriate recovery and resolutions plans. GSCs will need to have appropriate arrangements to support an orderly wind-down in the event of distress, including to ensure critical functions can continue.
  • Transparency on how the arrangement works. GSC arrangements are expected to provide transparency on the governance structure, stabilisation mechanism, investment mandate, custody arrangements, segregation measures and dispute resolution mechanisms, among other things.
  • Legal clarity on the nature and enforceability of any redemption rights and the process for redemption. In particular, users should be clear on what claims they have - against the reserve assets, the issuer or any guarantors - and on how those claims would be treated in the event of insolvency.
  • Systems that can adapt to new regulatory requirements as necessary. As international standards evolve, GSC arrangements will need to be able to adjust their operations as needed to maintain compliance.

2. Regulatory gaps

One of the primary purposes of the FSB’s work was to help national authorities identify any regulatory gaps which stablecoins may fall into. Given the cross-border nature of GSCs and the risks of regulatory arbitrage, the FSB is particularly concerned that national authorities address any such gaps in order to reach common international standards.

The report sets out a helpful framework (in Annex 2) to assist national authorities in conducting their own gaps analysis. However, it highlights the following common gaps in particular, based on survey responses:

  • Incomplete implementation of the AML/CTF recommendations of the Financial Action Taskforce (e.g. for peer-to peer transfers).
  • Inability to supervise an arrangement that falls outside existing frameworks (e.g. as e-money or a security). 
  • Incomplete regulation of exchanges, trading platforms, wallet providers and other market participants engaged in activities that are economically similar to those that currently fall within the regulatory perimeter.
  • No specific capital or liquidity requirements for issuing stablecoins or managing reserve assets.
  • Incomplete measures to address cyber security or operational risks in relation to the technology used for operating the infrastructure, validating transactions or storing keys in wallets.

As we know, the European Commission has been seeking views on a number of these issues in its ongoing consultation on crypto-assets.

3. How GSCs will be supervised across borders

Typically, cross-border supervision of financial institutions and financial market infrastructures is based on the concepts of “home” and “host” jurisdictions. The supervisor in the “home” jurisdiction takes primary responsibility for consolidated supervision and cooperates with authorities in relevant “host” jurisdictions as needed.

The FSB report identifies that these concepts may not sit well with GSC arrangements, which are often operated through loose networks of entities and control structures. As such, it flags that new forms of cooperation may be needed.

It stresses the importance of supervisory collaboration and information sharing in this regard, and points to various international standards and examples of bespoke arrangements to guide authorities through these new waters.

Next steps

The FSB has invited stakeholders to comment on its consultation report by 15 July 2020. It aims to publish a final report in October 2020.

Our global Fintech team welcomes any questions that you may have concerning the FSB consultation paper, stablecoins or any other digital assets or matters.