Week of July 15, 2022

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Good morning and thank you for subscribing. This week, we cover SEC Chair Gensler's interview discussing crypto regulation and a white paper on CBDCs.

Top Points

• SEC Chair Gensler says he is willing to tailor disclosure requirements under securities laws for crypto companies using the SEC's exemptive authority.
• The Office of Financial Research published a white paper on Central Bank Digital Currencies ("CBDC"), finding "a well-designed CBDC may decrease rather than increase financial fragility."

SEC Chairman Gary Gensler says in interview with Yahoo Finance that disclosure requirements under securities laws can be tailored for crypto firms using the SEC's exemptive authority.

When asked about applying disclosure rules under securities laws to crypto, SEC Chair Gensler responded:

• “We at the SEC have a disclosure regime, as you said. I’ve said to the industry, to the lending platforms, to the trading platforms, come in, talk to us. We do also have robust authorities from Congress also to use their exemptive authority so that we can tailor investor protection, and in your specific question about the tokens themselves, even tailoring what the disclosures might be. Because maybe not all of the disclosures for somebody issuing equity are the same as a a crypto token.”

When asked what to expect from the SEC in the future, Chair Gensler noted that the SEC is working with the exchanges, the lending platforms, and the broker-dealers, about how to come into compliance with securities laws.

• "The public is not protected largely because of the non-compliance in [the crypto] space."

So What?

The interview reaffirmed Chair Gensler's position that most of the crypto industry is subject to SEC jurisdiction and securities laws, as well as his desire for crypto firms to "come on in" and register with the SEC.

By highlighting the SEC's broad authority to issue exemptions to tailor disclosure requirements, Chair Gensler may be seeking to make registration with the SEC more attractive, as so far, most firms have been reluctant to "come on in."

Logically, for the exemption to apply, the underlying subject matter (in this case, crypto and certain crypto companies), must be subject to the securities laws in the first place. This is a point of contention, as no clear standard exists as to which cryptos are securities and which are commodities.

Moreover, two U.S. bills (with bipartisan support) pending in the 117th Congress would provide the Commodities Futures Trading Commission, not the SEC, with primary jurisdiction over cryptocurrencies and crypto exchanges. See Lummis-Gillibrand Responsible Financial Innovation Act, Title IV; See also Digital Commodity Exchange Act of 2022.

Thus, despite the Chairman's statements, the extent to which we will see an SEC disclosure by exemption regime for crypto move forward is, at best, unclear.

SEC's "General Exemptive Authority"

Disclosure requirements under securities laws are largely governed by the Securities Act of 1933 and the Securities Exchange Act of 1934.

In 1996, Congress granted the SEC broad authority to issue exemptions from these laws by enacting the National Securities Markets Improvement Act ("NSMIA"). See NSMIA § 105 ("Exemptive Authority") here.

NSMIA authorized the SEC to exempt any "person, security, or transaction" or "any class or classes of persons, securities, or transactions" from provisions of the Securities Act of 1933 and Securities Exchange Act of 1934, as well as any rules and regulations issued thereunder, so long as the exemption is in the public interest and consistent with the protection of investors. See Securities Act of 1933 § 28 (15 U.S. Code § 77z–3); See Securities Exchange Act of 1934 § 36 (15 U.S. Code § 78mm).

For example, Section 28 of the Securities Act of 1933 reads as follows:

According to Chair Gensler, relying on existing securities laws and exemptive authority to tailor disclosure requirements for crypto would serve the public interest and protect investors by bolstering information available to the public.

• "The public benefits by knowing full and fair disclosure and that somebody is not lying to them."

The full interview can be viewed here.

The Office of Financial Research ("OFR") published a working paper on CBDCs, concluding a CBDC might, in fact, decrease financial risk.

The highly technical working paper examined the extent to which a CBDC may lead to increased bank runs during times of financial stress--a concern commonly raised by policymakers.

The paper, found here, identifies two major factors that could mitigate this concern and concludes that a well-designed CBDC may actually decrease financial risk.

According to the paper, those two factors are:

First, banks do less "maturity transformation" when depositors have access to a CBDC, which leaves them less exposed to bank runs.

• ​Maturity transformation is when banks take short-term sources of finance, such as customer deposits, and turn them into long-term borrowings, such as mortgages.

Second, monitoring the flow of funds into a CBDC allows policymakers to identify and resolve weak banks sooner, which also decreases depositors’ incentive to pull deposits at weak banks.

• But note, a key policy concern against CBDCs is precisely the fear that the government will monitor how individuals utilize their own money.

Background:

Dodd-Frank established the OFR in 2010 to provide financial research in support of the Financial Stability Oversight Council ("FSOC"). FSOC, also established under Dodd-Frank, is tasked with identifying risks to the financial stability of the United States.

So What?

President Biden's Executive Order on digital assets charges the Department of Treasury, in consultation with other agencies, with issuing a report analyzing the potential impact of a U.S. CBDC. See § 4(b)(i)- (vii).

• Because OFR reports to Treasury, OFR's working paper may shed light on what to expect from Treasury's report on CBDCs, due September 5.

More generally, advocates of a U.S. CBDC will likely use the paper's findings to counter arguments that a U.S. CBDC may lead to increased risk of bank runs.

• For example, in a House Financial Services hearing on May 27, several members of Congress, as well as Federal Reserve Vice Chair Brainard, cautioned that a U.S. CBDC may weaken demand for traditional bank deposits.
• And in times of financial stress, risk-averse consumers may move bank account funds into CBDC accounts, triggering private bank runs, and potentially threatening financial stability.

Look Ahead

• On Tuesday, July 19, at 10am ET, the House Committee on Financial Services Subcommittee on Investor Protection, Entrepreneurship, and Capital Markets will host a hearing on "Oversight of the SEC's Division of Enforcement."
  • Following Chair Gensler's comments this week, watch for questions and comments challenging whether the SEC does in fact have authority to apply securities laws to vast swaths of the crypto industry and/or questions as to how the SEC might use its exemptive authority to tailor regulations for crypto firms.

Worth the Read

• The European Central Bank released a white paper on "A deep dive into crypto financial risks: stablecoins, DeFi and climate transition risk."
• ​Celsius files for bankruptcy. (CNBC: Kate Rooney, Paige Tortorelli).
• ​Yes, Crypto Still Matters. (Dante Disparte, Chief Strategy Officer and Head of Global Policy, Circle).

Trivia

Last week's A: Martha Washington is the only woman to grace the official portrait of U.S. paper currency.

This week's Q: Which of the following is NOT included in the market basket of goods used to determine the Consumer Price Index (CPI)?

(a) College tuition; (b) Income tax (c) Coffee (d) Sales tax.

Thank you for subscribing, and have a great weekend.

Sincerely,

GSL

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