Stablecoin Regimes Risk Spurring Regulatory Arbitrage, Warns FSB

October 11, 2021
The different approaches being taken towards the Financial Stability Board’s stablecoin recommendations could have negative consequences for financial markets, the standard-setting body has warned.

The different approaches being taken towards the Financial Stability Board’s (FSB) stablecoin recommendations could have negative consequences for financial markets, the standard-setting body has warned.

As the stablecoin landscape is evolving rapidly and as regulatory and supervisory policies are being developed, the differences among regulatory approaches and classifications could be increasing, the FSB has suggested in its latest progress report on the standard-setting bodies high-level recommendations.

In the report, the FSB acknowledges that although the current generation stablecoins are not being used for mainstream payments on a significant scale, vulnerabilities in this space have continued to grow over the course of 2020-21.

The report further outlines that the implementation of the FSB high-level recommendations to address the regulatory, supervisory and oversight challenges raised by global stablecoins (GSC) arrangements across the various jurisdictions is still at an early stage.

For example, certain markets are seeking to implement the recommendations through the adoption of new rules and regulations, while others have amended or plan to amend existing rules and regulations in such a way that these are applicable to stablecoins.

Furthermore, other jurisdictions have relied largely on existing regulatory, supervisory and oversight regimes to address the risks associated with stablecoins or with entities that are part of the stablecoin arrangement, the Basel-based standards-setting body said.

“Differing regulatory classifications and approaches to stablecoins at jurisdictional level could give rise to the risk of regulatory arbitrage and harmful market fragmentation,” the report warns.

However, some close to the industry have played down the prospect of this becoming a problem.

“Each stablecoin will be linked to an asset, such as fiat money, gold or another asset, so I don’t think arbitrage would be a problem at first sight,” said Joaquim Matinero Tor, a banking and finance lawyer at Barcelona-based firm Roca Junyent.

Expecting that many stablecoins will not have the impact expected, central bank digital currencies (CBDC) developed by the likes of the People’s Bank of China or the US Federal Reserve are likely to end up dominating the market for digital currencies.

Although significant players such as Mastercard and Visa have begun to adapt their networks to become more accommodating to digital currencies, stablecoins remain niche.

"Compared to the crazy size of financial markets, stablecoins are still small but their success stories are there already,” said Kristian T. Sørensen, founding partner at Denmark-based fintech consultancy Norfico.

For example, French bank Société Générale has proposed launching a stablecoin for the bond markets, while US decentralised finance platform CIRCLE is in the process of applying for a banking licence.

For stablecoin players, stricter regulatory regimes are both a blessing and a curse, said Sørensen. “There is the element that regulations that are too harsh prevent development, but players are welcoming of regulation,” he said.

“It is a stamp of approval and can help accelerate adoption beyond hardcore crypto communities,” he pointed out.

Regulators want to have everything under control so it’s understandable from their point of view to be introducing strict rules as the market grows, added Matinero Tor.

“However, a stablecoin that is so restricted would not be effective or efficient so people could prefer crypto-assets to centralised stablecoins,” he pointed out.

Continued Progress

Various jurisdictions have begun to propose new regulations for stablecoin providers. The Monetary Authority of Singapore has consulted on adjusting its 2019 Payment Services Act (PSA) to better account for stablecoins.

Through the PSA, established legal definitions of e-money and cryptocurrencies are being challenged by the emergence of stablecoins.

The EU has also proposed new legislation in the form of the Markets in Crypto Assets (MiCA) regulation. MiCA sets out a comprehensive regulatory framework for all crypto-assets not already covered under other European financial services legislation, including stablecoins.

As it stands, MiCA sets out two different sets of obligations for issuers of stablecoins depending on whether they issue stablecoins referencing a basket of assets (asset-referenced tokens) or a single official currency (e-money tokens).

Issuers of both stablecoins will be subject to an authorisation requirement in EU member states and must prepare a white paper outlining the details of their stablecoin product.

This echoes the FSB’s recommendation that GSC arrangements are expected to adhere to all applicable regulatory standards and to address risks to financial stability before commencing operation, and adapt to new regulatory requirements as necessary.

Stablecoins are viewed as a priority in the MiCA legislation, with European Commission officials having confirmed that the regulatory regime will fast-track stablecoin rules once it is passed into law.

Finance ministers in many of the EU member states have already insisted that stablecoins should not be allowed to operate in the EU’s single market until a legal framework has been put in place.

Further work to be done

As jurisdictions use the FSB’s high-level recommendations in developing their own domestic regulatory approaches, the FSB report notes that authorities have identified several issues relating to the implementation of the recommendations that may warrant further consideration and where further work at the international level could be useful.

Areas for further consideration by the FSB include: conditions for qualifying a stablecoin as a GSC; prudential and investor protections; and requirements for different parts of the ecosystem, such as issuers, custodians and wallet providers.

“Further work on these issues at the international level may help to support the effective implementation of the FSB high-level recommendations at the jurisdictional level, to mitigate the risk of regulatory fragmentation and arbitrage, and to address risks to financial stability arising from GSCs,” the FSB has indicated.

The FSB report concludes that any efforts by standard-setting bodies such as the FSB and the Bank for International Settlements to review, and where appropriate adjust their standards, will further promote international consistency and reduce the risk of arbitrage or regulatory underlaps.

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