The Financial Stability Board (FSB) today published for consultation 10 high-level recommendations to address what it sees as the regulatory, supervisory and oversight challenges raised by global stablecoin (GSC) arrangements.
With continuing technological innovation in the financial sector as well as the COVID-19 pandemic, alternatives to cash may become yet more attractive, notes the FSB in a statement. Stablecoins, like other crypto-assets, have the potential to enhance the efficiency of the provision of financial services, but may also generate risks to financial stability, the FSB notes. Stablecoins are meant to stabilise the price of the coin by linking its value to a pool of assets.
“The activities associated with global stablecoins and the risks they may pose can span across banking, payments and securities/investment regulatory regimes both within jurisdictions and across borders,” notes FSB in a statement. “These potential risks may change over time, and so challenge the effectiveness of existing regulatory, supervisory and oversight approaches. Ensuring the appropriate regulatory approach within jurisdictions across sectors and borders will therefore be important.”
The FSB’s recommendations call for regulation, supervision and oversight, and stress the need for “flexible, efficient, inclusive and multi-sectoral cross-border cooperation, coordination and information sharing arrangements that take into account the evolution of global stablecoin arrangements and the risks they may pose over time”. They apply the principle of ‘same business – same risks – same rules’, independent of the underlying technology, says FSB.
Financial stability risks from the current use of stablecoins are currently contained, due largely to the relatively small scale of use, notes FSB. However, the use of stablecoins as a means of payment or a store of value might significantly increase in the future, possibly across multiple jurisdictions. In addition, the different activities within a stablecoin arrangement, in particular those related to managing the reserve assets, may considerably increase linkages to the existing financial system, FSB notes.
Potential Risks of GSCs to Financial Stability
GSCs could pose financial stability risks through some key channels, notes FSB. First, if a GSC were used as a common store of value, even a moderate variation in its value might cause significant fluctuations in users’ wealth, which could be sizeable enough to affect spending decisions and economic activity. These effects may be particularly pronounced in Emerging Market and Developing Economies (EMDE), where the likelihood of GSCs becoming a mainstream store of value could be higher than in advanced economies (AE), says FSB.
Second, if widely used for payments, any operational disruption might have significant impacts on economic activity and financial system functioning, notes FSB. If users relied on a stablecoin to make regular payments, “significant operational disruptions” could quickly affect real economic activity (eg, by blocking remittances and other payments), it suggests. Large-scale flows of funds into or out of the GSC could test the ability of the supporting infrastructure to handle high transaction volumes and the financing conditions of the wider financial system, FSB states.
Third, exposures of financial institutions might increase in scale and change in nature – particularly if financial institutions played multiple roles within a GSC arrangement (for example as resellers, wallet providers, managers or custodians/trustees of reserve assets). This may be a source of market, credit and operational risks to those institutions, cautions FSB.
In addition, the large-scale use of GSCs might magnify confidence effects. “A greater sensitivity to confidence effects could also reflect the extent of the use of a GSC as a store of value and/or means of payment,” says FSB. “Moreover, closer linkages to financial institutions might also expose a GSC to adverse confidence effects, such as when a financial institution that acts as reseller/market maker of the GSC arrangement comes under financial distress. The reverse may also be true – the potential failure of a GSC might expose the financial institutions involved in the GSC arrangement to adverse confidence effects.”
FSB warns that a disruption to payments could also cause a further decline in confidence, which in turn could prompt further redemptions and decline in the GSC’s value, compounding wealth effects.
Macrofinancial risks may arise particularly if, over time, households and businesses in some economies (eg, EMDEs) come to hold substantial portions of their wealth in GSCs, rather than in local currencies. During periods of stress, households in some countries might come to regard GSCs as a safe store of value over existing fiat currencies and exacerbate destabilising capital flows. Volatile capital flows can have a destabilising effect on exchange rates and on domestic bank funding and intermediation, notes FSB.
The significance of these channels and their impact on financial stability depend on how widely and for what purpose a GSC is used, and whether linkages to the financial system increase, FSB notes. “For example, if a GSC were adopted as a widespread means of payment, but not as a store of value, its potential implications for financial stability may be narrower. If, however, a GSC also became adopted as a significant store of value by some of its users, other channels – including those pertaining to confidence effects, interlinkages to financial institutions and macroeconomic stability – may become more prominent,” it states.
While the significance of the individual channels depends on what a GSC is used for and how widely it is used, the vulnerability of the GSC itself to shocks depends on how the functions and activities of the arrangement are designed and performed, says FSB, which identifies three main types of vulnerabilities.
The first type relates to traditional financial risks – market, liquidity and credit risk. FSB notes that the choice and management of the GSC reserve assets, particularly the degree to which they could be liquidated at or close to prevailing market prices, is key to avoid large-scale GSC redemptions or “fire sales” of reserve assets that could reduce the “stable” value of the coin. Large-scale redemptions of GSCs might lead to large-scale sales of other assets and stress transmitted to wider financial markets. Similarly, significant changes in the composition of the reserve assets, in the absence of large-scale redemption of GSCs, might trigger spillover effects to the wider financial system.
FSB also notes that the ability to sell reserve assets in large volume at (or close to) prevailing market prices would depend on the duration, quality, liquidity and concentration of the GSC’s reserve assets. The degree of transparency as to the nature, sufficiency and liquidity of these reserve assets might also affect confidence in the GSC.
Other design features may add to financial stability risks, FSB notes. “The withdrawal of liquidity provision by resellers/market makers might cause a sharp reduction in the liquidity of the GSC and dislocation in its price, which might in turn undermine user confidence and prompt further redemption. Moreover, users’ loss of confidence could be more pronounced for GSCs which are not fully backed by reserve assets,” it states.
A second type of vulnerability concerns potential fragilities in the governance, operation and design of the GSC’s infrastructure, including its ledger and the manner of validating users’ ownership and transfer of coins, says FSB. “This vulnerability could crystallise, for example, due to an operational incident at a custodian or a compromised ledger resulting from a design defect, a cyber incident, or a failure of validator nodes. A lack of network capacity to validate – and subsequent delays in processing – large volumes of transactions might amplify users’ loss of confidence, and trigger further redemption requests.”
In the event of a disruption in the GSC arrangement, ambiguity about rights and protection afforded to users could amplify confidence effects, it notes. In particular, if users do not have redemption rights or a direct claim on the underlying assets, confidence could be undermined.
The degree of vulnerability would be impacted by the effectiveness of the GSC arrangement’s governance and controls. The clarity of the roles and responsibilities of the GSC’s governance body – including in respect of setting and enforcing the rules on establishing the GSC’s value and on the functioning of the infrastructure – could affect users’ confidence, says FSB.
The third vulnerability relates to the applications and components on which users rely to store private keys and exchange coins. Such vulnerabilities could crystallise due to an operational incident at a wallet or exchange, for example. The scope of affected users might depend on the market share of the associated provider, and the degree to which it, for example, serves users in different jurisdictions, says FSB.
The degree of vulnerability would depend on the operational resilience arrangements for wallets and exchanges, including stand-in and fall-back arrangements that ensure continuity of service to users, and of the continued liquidity of the secondary market for coins.
The interlinkages that exist between the various functions and activities in a GSC arrangement may add to vulnerabilities, adds FSB. For instance, a design failure in the validation process used for coin transfers could undermine confidence in the payment mechanism, but also in the performance of GSCs as a store of value and eventually of the GSC arrangement as a whole. As a consequence, the resilience of the arrangement may depend on the proper functioning of a range of different activities and processes, it states.
Recommendations for Regulation, Supervision, Oversight
FSB sets out 10 high-level recommendations to promote consistent and effective regulation, supervision, and oversight of GSCs.
- Authorities should have and utilise the necessary powers and tools, and adequate resources, to comprehensively regulate, supervise, and oversee a GSC arrangement and its multi-functional activities, and enforce relevant laws and regulations effectively.
- Authorities should apply regulatory requirements to GSC arrangements on a functional basis and proportionate to their risks.
- Authorities should ensure that there is comprehensive regulation, supervision and oversight of the GSC arrangement across borders and sectors. Authorities should cooperate and coordinate with each other, both domestically and internationally, to foster efficient and effective communication and consultation in order to support each other in fulfilling their respective mandates and to facilitate comprehensive regulation, supervision, and oversight of a GSC arrangement across borders and sectors.
- Authorities should ensure that GSC arrangements have in place a comprehensive governance framework with a clear allocation of accountability for the functions and activities within the GSC arrangement.
- Authorities should ensure that GSC arrangements have effective risk management frameworks in place especially with regard to reserve management, operational resiliency, cyber security safeguards and AML/CFT measures, as well as “fit and proper” requirements.
- Authorities should ensure that GSC arrangements have in place robust systems for safeguarding, collecting, storing and managing data.
- Authorities should ensure that GSC arrangements have appropriate recovery and resolution plans.
- Authorities should ensure that GSC arrangements provide to users and relevant stakeholders comprehensive and transparent information necessary to understand the functioning of the GSC arrangement, including with respect to its stabilisation mechanism.
- Authorities should ensure that GSC arrangements provide legal clarity to users on the nature and enforceability of any redemption rights and the process for redemption, where applicable.
- Authorities should ensure that GSC arrangements meet all applicable regulatory, supervisory and oversight requirements of a particular jurisdiction before commencing any operations in that jurisdiction, and construct systems and products that can adapt to new regulatory requirements as necessary.
The consultation paper will be delivered to G20 Finance Ministers and Central Bank Governors on Wednesday. The public consultation period closes on Wednesday 15 July. The final recommendations, including feedback from the public consultation, will be published in October. The full paper can be found at: https://www.fsb.org/wp-content/uploads/P140420-1.pdf