New York State Department of Financial Services Issues Guidance Addressing USD-Backed Stablecoins; Proposed Responsible Financial Innovation Act Addresses Similar Concerns

DFS Guidance

The New York State Department of Financial Services (DFS) Superintendent Adrienne A. Harris issued new DFS Regulatory Guidance (Guidance) on June 8, 2022,¹ setting foundational criteria for USD-backed stablecoins issued by DFS-regulated entities. The purpose of the Guidance is to “set forth baseline requirements that will generally apply to stablecoins backed by the U.S. dollar that are issued under DFS oversight.” Pursuant to the Guidance, DFS generally will impose the conditions set forth below.

DFS Requirements

Backing and Redeemability
DFS set forth two prongs to this condition: the stablecoin must be fully backed; and there must be procedures in place to permit lawful holders to redeem the stablecoin in a timely fashion.

To meet the backing prong, the stablecoin must be fully backed by having a sufficient amount of assets in reserve (Reserve) backing the value of the stablecoin, meaning that “the market value of the Reserve is at least equal to the nominal value of all outstanding units of the stablecoin as of the end of each business day.”²

To meet the redeemability prong, the issuer of the stablecoin (Issuer) must be able to redeem holders of the stablecoin within two business days of the redemption request. To demonstrate compliance with the redemption prong, the Guidance states that the Issuer “must adopt clear, conspicuous redemption policies, approved in advance by DFS in writing, that confer on any lawful holder of the stablecoin a right to redeem units of the stablecoin from the Issuer in a timely fashion at par” for U.S. dollars, “subject to reasonable, non-burdensome conditions including otherwise applicable legal or regulatory requirements.” The Guidance emphasizes that the Issuer must clearly disclose the meaning of the terms “redemption” and “timely” or follow the default terms provided in the Guidance.

Reserve
To meet the reserve requirements condition, the Issuer must segregate the assets in the Reserve from the Issuer’s proprietary assets. The Reserve assets must be held in custody for the benefit of stablecoin holders with U.S. state or federally chartered insured depository institutions and/or asset custodians approved by DFS. The Reserve assets must be managed to enable the Issuer to meet its redemption requirements (i.e., by maintaining sufficient liquidity to meet redemption requests within two business days). The Guidance also specifies the type of assets allowed in the Reserve, which are: U.S. Treasury bills acquired by the Issuer no later than three months before their respective maturities; reverse repurchase agreements fully collateralized by U.S. Treasury bills, U.S. Treasury notes, and/or U.S. Treasury bonds on an overnight basis, subject to DFS-approved requirements concerning overcollateralization; government money market funds, subject to DFS-approved caps and DFS-approved restrictions; and deposit accounts at U.S. state or federally chartered insured depository institutions, subject to DFS-approved restrictions.

Independent Audits
The Guidance requires independent audits and monthly and annual attestations by an independent auditor. Specifically, the Reserve “must be subject to an examination of management’s assertions ... at least once per month” by an independent Certified Public Accountant. The monthly attestation must be made available to the public and delivered to DFS. Issuers also must obtain an annual attestation report from an independent CPA attesting to “management’s assertions concerning the effectiveness of the internal controls, structure, and procedures for compliance with the requirements” of the monthly attestation. Unlike the monthly attestation, DFS does not require that the annual report be made public, but it must be delivered to DFS within 120 days of the covered period.

The Guidance comes in the wake of the TerraUSD (UST) collapse, which has raised general market concern and discussion regarding the nature of stablecoins and the requirements that ought to apply. As a point of distinction, however, UST is an “algorithmic” stablecoin that is not backed at least 1:1 by assets, as the Guidance requires, and as recent federal legislative proposals seek to require. Under the Guidance, an asset such as UST would not be permitted to be issued by a DFS-regulated entity.

Proposed Federal Legislation

Similarly timed and in line with the spirit of the Guidance, on June 7, 2022, Senators Cynthia Lummis (R-Wyo.) and Kirsten Gillibrand (D-N.Y.) introduced the Responsible Financial Innovation Act (RFIA), a legislative proposal to create a regulatory framework for digital assets in the United States, providing rules regarding, among other matters, the issuance of payment stablecoins.³ The RFIA would require all issuers of payment stablecoins to: maintain high-quality liquid assets valued at 100% of the face value of all outstanding payment stablecoins; provide public disclosures of the assets backing the stablecoin and their value; and have the ability to redeem all outstanding payment stablecoins at par in legal tender.⁴ The RFIA also sets forth a detailed, optional process for depository institutions (e.g., banks/credit unions) to issue a payment stablecoin.

Both the Guidance and the RFIA focus on: maintaining sufficient reserves; implementing reporting requirements; and requiring clear terms for redemption. This concern is grounded both in the recent events with UST, as well as in DFS’ prior experience with Tether’s USDT. In early 2021, the New York Attorney General reached an agreement with Tether and Bitfinex,⁵ stating that their stablecoin, USDT, had not been always fully backed by U.S. dollars. Consequently, the agreement requires that Tether and Bitfinex discontinue business activity in New York.

Conclusion

The Guidance may inspire other states to take a similar approach with respect to stablecoin regulation, either through revisions to existing money transmission regulations or through the passing of digital asset-specific legislation, as is currently under consideration in California. Likewise, the RFIA, although still far from becoming law, may provide a roadmap for regulators and future legislation at the state and federal levels.

Footnotes
1) Superintendent Adrienne A. Harris Announces New DFS Regulatory Guidance On The Issuance Of U.S. Dollar-Backed Stablecoins (June 8, 2022).
2) RE: Guidance on the Issuance of U.S. Dollar-Backed Stablecoins (June 8, 2022).
3) Responsible Financial Innovation Act (June 6, 2022).
The stated purpose of the RIFA is to provide for responsible financial innovation and to bring digital assets within the regulatory perimeter.
4) Lummis-Gillibrand Responsible Financial Innovation Act: Section-by-Section Overview (June 6, 2022).
5) Attorney General James Ends Virtual Currency Trading Platform Bitfinex’s Illegal Activities in New York (February 23, 2021).