Treasury Says New Law Only Way to Fully Contain Stablecoin Risks

Bloomberg — The U.S. Treasury’s top official for financial oversight said government regulators need action from lawmakers to adequately protect investors — and the wider financial system — from risks posed by stablecoins.

“If Congress does not enact legislation, the regulators will try to use what authority they have,” but they will be left without sufficient oversight powers, Nellie Liang, the Treasury undersecretary for domestic finance, said Friday in an interview with Bloomberg News, referring to what agencies can do without congressionally mandated authority.

Investors in the cryptocurrency space often use stablecoins to get in and out of trades, using them as a digital form of money, highlighting the importance of their regulation.

Liang, who formerly led the Federal Reserve’s financial-stability division, said of regulators: “They can do a little here and a little there, but if these are foundational to crypto assets and they aren’t stable, that could potentially be a big risk.”

She spoke shortly after a panel of top federal regulators released its annual report outlining threats to the U.S. financial system. In that report, the Financial Stability Oversight Council said it is prepared to take steps on its own to address stablecoins if Congress fails to pass legislation.

Not a Plan B

But Liang readily conceded that’s “not a good Plan B. We wouldn’t call it a Plan B.”

“We need congressional action to address the prudential risks of stablecoins,” she said.

In November, a smaller group of federal agencies, including the Fed, appealed to Congress to act because of “key gaps” in regulatory authority over stablecoins. They urged legislators to require that stablecoin issuers become insured depository institutions, subjecting them to oversight from banking regulators.

Liang agreed, saying such oversight would allow agencies to examine them for operational risks, apply broad safety and soundness standards and assess their ability to pose collective, system-wide risks.

Stablecoins are a fast-growing type of cryptocurreny whose value is pegged to another asset, like a traditional currency or commodity. Most, like Tether — the largest, with about $76 billion in outstanding tokens — are pegged to the U.S. dollar.

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Strengthening Role

The tokens maintain a stable value by promising to keep reserves equal to their liabilities. But regulators worry those aren’t reliable, making investor runs possible. Aside from the risk to investors, such runs might also be more widely destabilizing if stablecoins continue their rapid growth.

Currently, they serve mostly as a digital-currency bridge for investors seeking to trade in cryptocurrencies like Bitcoin, whose values can fluctuate wildly. But their issuance could expand dramatically if they are adopted as a widespread tool for everyday payments.

Liang expressed optimism that U.S. lawmakers are beginning to engage seriously on the issue.

“Fortunately, Congress is thinking about this, and working on these issues and holding hearings,” she said.

Senator Pat Toomey of Pennsylvania, the top Republican on the Senate Banking Committee, touted the potential for stablecoins to make payments faster and less costly at a committee hearing Tuesday. He also released a blueprint for future legislation the same day.

But a Republican proposal would face an uphill battle in the evenly divided Senate, and with key Democrats, including Banking panel Chair Sherrod Brown of Ohio and committee member Elizabeth Warren of Massachusetts, having a much more critical take on the tokens.

Treasury Securities Market

Separately, Liang said that a group of agencies had made “considerable progress” on reforms to the structure of the market for Treasury securities. That market has grown increasingly susceptibleto bouts of low liquidity during times of stress.

Several times in past years investors have briefly fled the market. In March 2020, just as the Covid-19 pandemic struck the U.S., liquidity in Treasuries nearly disappeared, threatening to freeze global credit markets and necessitating a giant buying intervention by the Fed.

Worries over the market have only grown, especially as the Fed prepares to halt its pandemic Treasuries-purchase program next spring.

Read More: Federal Regulators Inch Closer to Treasuries-Market Reforms

Liang said the regulatory group had “a pretty aggressive work plan for the next year” covering all five areas identified in a November report, but would not give any timeline for when to expect concrete proposals.

SEC Proposal

Meantime, the Treasury undersecretary reacted positively to new rules proposed this week by the Securities and Exchange Commission for money market funds, calling them “a great step.”

The proposals would raise the minimum liquidity thresholds and introduce so-called swing-pricing for institutional funds, a mechanism that would introduce extra costs for investors who are withdrawing when a fund is experiencing net redemptions.

“If swing-pricing is executed appropriately, it should reduce the advantage of redeeming first and therefore should prevent runs or reduce significant runs,” Liang said.

Money funds, which aim to preserve the value of holdings and provide daily liquidity, have experienced two runs in the past 13 years that helped cripple short-term credit markets and forced the Fed to enter as an emergency buyer of fund holdings. Rule changes prompted after the 2007-09 financial crisis failed to prevent another run in March 2020 at the outset of the pandemic.