'Stablecoins' are typically viewed as a proxy for money, so we do need to be careful about their use and the potential risks that they create. To this end, the FSB has authored a paper on stablecoins: "Addressing the regulatory, supervisory and oversight challenges raised by “global stablecoin” arrangements”.
In this post we cover Fnality’s aims and our general view on the recommendations. Subsequent posts will detail our views on the specific questions asked and our final response.
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Fnality is creating a new global payments network to enable the development of tokenised markets to serve the wholesale sector. Fnality is expressly focusing on the cross-border elements of wholesale, so in time there will be a global nature to Its business. In each currency, Fnality is an independent regulated payment system with transactions subject to the local laws on settlement finality. In each Fnality system, the aggregate balances will correspond to cash held with the central bank which is bankruptcy remote from the Fnality entity operating system. A structure which we believe sets us apart.
Definitions are often a challenge. The FSB’s definition is broad and they recognise this; some so called stablecoins may be supported by an algorithm, others by cash held at a central bank, or by cash held with a commercial bank or with a basket of investments. This already calls for a broad view of what is stable and more importantly, what the risk parameters are within which something that is stable becomes unstable. In our opinion, a tokenised cash asset that has a guaranteed redemption at par in fiat currency is very different from a Global Stable Coin (GSC) that is linked to a basket of securities or currencies whose value can vary. The risks associated with the former are clearly significantly lower than the risks associated with the latter. Market turmoil in-mid March 2020 illustrates these risks really clearly. On March 16th. Money market funds struggled to sell even the most “highly liquid” assets and borrowers struggled to borrow; cf. “The Day Coronavirus Nearly Broke the Financial Markets”, Justin Baer, WSJ, May 20.
Secondly, it is important that regulation should be applied to functions rather than to technology. Payment activity should be regulated according to its risks not regulated differently because it happens to use a new form of technology in the form of DLT and cryptography. If there is a desire to see new innovation flourish which allows more effective and efficient approaches to be applied, this distinction must be maintained. Clearly, if some GSCs introduce new risks, e.g. investment and intermediary risks, these must be accounted for both in terms of how these risks are managed and regulated, and the transparency associated with said risks.
So, with this in mind, here’s how we are thinking about these FSB guidance principles.
- If a GSC arrangement has the characteristics of a payment system, then it should be regulated as one. Sound regulation follows the “same business, same risk, same rules” principle. The technology that is used to provide financial services and products should not matter as long as the operator meets the standards and plays by the rules. If a provider uses distributed ledger technology to enable payments between counter-parties, it should be classified accordingly: as a payment system. Not surprisingly, essentially all risks mentioned in the consultative document are not unique to GSC arrangements, but they already exist in conventional transfer schemes;
- We view the existing regulatory frameworks and tools as adequate to ensure that GSC arrangements are adequately safe. In particular, regulators and overseers need to ensure that the potential risks to financial stability as outlined in Section 2.1. of the consultative document do not materialise, e.g. by requiring the reserve assets to be of high quality and liquid;
- The consultative document points to the CPMI-IOSCO preliminary analysis establishing that the PFMI should apply to stablecoin arrangements performing systemically important payment system functions. Furthermore, recommendations 1 to 7 and 10 apply generally to payment systems. Recommendations 8 & 9 would apply functions, such as investing the cash held;
- The recommendations necessarily and rightly include proposals for those cases where a GSC operates an “investment function” (cf. recommendations 8 & 9). It is not important whether something is considered a coin, a token or a payment system, what is important is that any additional risks associated witha particular construct are duly accounted for, and globally, regulators have a shared understanding of how to address those risks. Recommendations 8 & 9 regarding transparency and commitments around redemption, respectively, focus on the investment related controls needed in such cases. The easy way to think about this is if you are holding something out to be “stable” and promising redemption at par, you had better explain your definition of stable and how you ensure that redemption at par is guaranteed. This is a MiFID II type approach and will be familiar to anybody who saw what happened to retail investors in Lehman's “capital protected” products. If the scheme operator is not holding cash, but making investments, then redemption criteria & commitments need to be clear.
In summary, having a classification of GSCs may be both useful and necessary; it highlights to the public, to investors and to national regulators that when it comes to the “business of money” today‘s and tomorrow’s worlds will include offerings which are global and systemically relevant and that those charged with oversight and ensuring financial stability have the right tools to manage the risks that accompany such offerings. The G-SIB designation is an example where cross-border issues & concerns have led to a specific categorisation and specific standards.
We believe that there is one key principle to managing any GSC categorisation of offerings; any supervisory regime should be commensurate to the activity that is being carried out; any coin, structure or system which acts like a payment system should be regulated and supervised as one. If new forms of risks such as investment or AML risks are introduced, suitable supervisory measures should be applied to cover those risks.
There is a need to strike a balance. Applying a one size fits all approach to an undefined, broad bucket of “GSCs” will potentially introduce overly restrictive measures for some. impacting necessary innovation, and insufficient measures for others, introducing unpalatable risks. The recommendations will be beneficial, as long as it is acknowledged and understood that not every recommendation will apply to every scheme or arrangement that might be considered a GSC.