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Last week saw major developments in fintech policy, with the most prominent being the enforcement actions taken by the Securities and Exchange Commission (SEC) against stablecoin issuers Paxos and Terraform Labs. Let’s dig in.

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1. Enforcement

On February 12, news broke that SEC issued a Wells Notice to stablecoin issuer Paxos, which issues Binance’s stablecoin (BUSD)—the third largest stablecoin by market cap. A Wells Notice is a notification from the SEC that it is considering taking enforcement action against a company or individual. The New York Department of Financial Services (NYDFS) also ordered Paxos to stop issuing BUSD, explaining that Paxos “violated its obligation to conduct tailored, periodic risk assessments and due diligence refreshes of Binance and Paxos-issued BUSD customers to prevent bad actors from using the platform.” At this point, it is not clear if this upcoming enforcement action means that the SEC considers all stablecoins unregistered securities, or if there are specific violations implicating the issuing of BUSD (the Wells Notice and the NYDFS order did not address USDP, the other stablecoin issued by Paxos). Meanwhile, Paxos mentioned that the Office of the Comptroller of the Currency (OCC) has not requested a withdrawal of its application to become a charted bank.

In other enforcement news, on February 16 the SEC filed a lawsuit against Terraform Labs and its co-founder Do Kwon. Terraform Labs is the issuer and manager of algorithmic stablecoin TerraUSD, which once was the third largest stablecoin by market cap before collapsing last May. The SEC alleges that Terraform committed fraud and sold unregistered securities and security-based swaps. The lawsuit poses two fundamental questions. The first is whether and how algorithmic stablecoins could be considered securities, and the second is about the implications of the multiplicity of legal proceedings crypto firms, which engage in a borderless activity by definition, may face in the case of failure.

2. Crypto Regulation

The SEC has been active on more than just the enforcement front. Last Wednesday, the SEC voted to propose rule changes to federal regulations that would require investment advisors registered with the SEC to entrust the safekeeping of client assets to qualified custodians. The proposed change involves expanding the scope of the custody rule to apply to all assets, including crypto assets. The goal, according to the SEC, is to extend standard custodial protections, such as the segregation of customers’ assets, to advisory clients’ assets. What does this mean? If the proposed rule changes are approved, crypto exchanges, such as Coinbase, would have to meet the definition of “qualified custodians” in order for investment advisors, such as hedge funds, to be able to entrust them with the custody of clients’ assets.

Other crypto regulation developments include: Sen. Elizabeth Warren’s (D-MA) plan to reintroduce a bill that strictly applies anti-money laundering laws to crypto firms around which she is trying to build a bipartisan coalition; the Wyoming House of Representatives passing a bill that prevents forced disclosure of digital wallets’ private keys except in exceptional circumstances; and New Jersey’s plans to issue a new crypto licensing regime similar to, if not stricter than, New York’s BiLicenese system. Internationally, the European Central Bank issued guidelines for banks to limit their holdings of crypto assets, and Hong Kong legalized trading in crypto assets for “accredited professional investors,” while trading remains completely banned in mainland China.

3. Payments

U.S. Bank issuers of debt cards are requesting a year-and-a-half extension of a July deadline set by the Federal Reserve to implement “Regulation II,” which requires bank issuers to offer to merchants debit networks other than those of Visa and Mastercard. Banks cited the very problem Regulation II is trying to solve, which is the lack of competition in the sector!

4. The UK (from the Policy Edition’s friends Joshua Kaplan and Chris Hurn)

On Monday 13 February, the UK Government published legislative proposals to bring most buy-now-pay-later and certain other types of short-term interest-free credit products into the UK regulatory perimeter. The proposal would bring sub-12 month, fixed sum, interest-free credit offered by third-party lenders to individuals and certain other types of protected borrowers within the scope of the majority of the existing UK consumer lending protections regime, including the jurisdiction of the Financial Ombudsman Service.  It would also subject relevant lenders to regulatory licensing requirements and to the UK Financial Conduct Authority’s rulebook.  The Government anticipates bringing the proposal into law during 2023, with a transitional licensing regime to enable lenders to continue to operate whilst obtaining relevant regulatory permissions.

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See you next week!