Revolution, not evolution: application of PFMI to systemic stablecoin arrangements

As part of an ongoing commitment by the international regulatory community to ensure new technologies are treated using the principle of ‘same risk, same regulation’, the Committee on Payments and Market Infrastructures and the International Organization of Securities Commissions (CPMI/IOSCO) are consulting on the application of the long standing Principles for Financial Market Infrastructures (PFMI) to systemic stablecoin arrangements (SAs).  

No new principles are proposed. Instead, the proposed guidance clarifies the application of certain (but not all) of the relevant payment system principles to systemic SAs. CPMI/IOSCO expect a systemically important SA to observe all of the relevant principles depending on its business (even if there is no specific guidance on the relevant principle or if the SA is not a payment system). 

Put simply, if a stablecoin system looks like a type of FMI (e.g. a payment system) and it’s systemically important, the principles applicable to that type of FMI will be relevant.

Multicurrency stablecoin arrangements (stablecoins denominated in or pegged to a basket of fiat currencies) are not in scope of this report – instead, they will be covered in future work.

What is a systemically important SA for these purposes?

CPMI/IOSCO have determined that the transfer of stablecoins (“transfer function”) of an SA is an FMI function, comparable to the transfer function performed by other FMIs.  The consultation cross-refers to the Financial Stability Board’s definition of stablecoins as “a crypto-asset that aims to maintain a stable value relative to a specified asset, or a pool or basket of assets”.

The consultation focuses on instruments that can be used as a means of payment or a store of value (rather than other digital assets or security tokens). If other FMI functions are performed, the SA should consider and observe the relevant principles, although this consultation does not consider these in detail.

The consultation highlights four overarching considerations t that authorities might take into account when assessing the systemic importance of an SA within its jurisdiction for the purpose of applying the PFMI:

• size of operations: whether a stablecoin is used as a principal payment or settlement mechanism in a particular jurisdiction or the market it serves. Factors to look at include the number of stablecoin users, the number and value of transactions and the value of stablecoins in circulation.
• nature and risk profile of the SA’s activity: the type or nature of the transactions and users. Authorities could consider (i) the type of stablecoin users, e.g. retail customers or financial entities; and (ii) the type or nature of transactions by looking at certain factors, e.g. are the transactions time critical, wholesale or retail in nature, cross-border payments, monetary operations, foreign exchange transactions.
• interconnectedness and interdependencies of the SA: whether there is significant interconnectedness and/or interdependencies with the real economy and financial system. For example: is the SA used to settle transactions for governments, important financial markets or other FMIs? How complex are the business, structure and operations of the SA and therefore the management challenges and risks involved?
• substitutability of the SA: whether there are alternatives to the SA as a means of payment or settlement for time-critical services.

In addition, CPMI/IOSCO suggest that authorities may, at their discretion, consider the potential growth and future state of an SA under development, when determining whether the SA is systemically important.

Why do stablecoin arrangements necessitate specific guidance?

Due to their structures and operations, SAs can pose novel and often unique issues, as well as having certain features that are more pronounced than in traditional FMIs.

The CPMI and IOSCO identify three areas where guidance is considered beneficial:

• the use of stablecoins as a settlement asset rather than central bank money or commercial bank money: this goes to the financial integrity of the entity performing the key functions of issuance and redemption of the SAs, the underlying assets that support the valuation of the stablecoins and the custody arrangements for those assets. Where an SA is systemic it is essential that investors can rely on the value of the stablecoins and the ability to redeem, both in normal and stressed market conditions;
• multiple interdependent functions: SA models are varied and different functions may be carried out by different entities, some of which may not be FMIs or may even be unregulated. The interdependencies between such different entities can create risks that need to be managed and addressed; and
• the use of technology (e.g. DLT) as well as the decentralisation of operations and/or governance: whilst traditional FMIs may make use of such technologies, they do so from an existing entity with a traditional management structure. The decentralisation of operations combined with the use of DLT technology may give rise to situations where there is no one to step in should unforeseen circumstances arise.

Which principles are covered?

Whilst a systemically important SA should observe all relevant principles of the PFMI, the consultation paper sets out guidance on four principles, where CPMI/IOSCO deem it to be helpful given features of SAs. The majority of the guidance is broadly along the lines we might expect in relation to those particular principles (e.g. ensuring that the SA’s ownership structure and operation allow for clear and direct lines of responsibility and accountability - irrespective of the governance arrangements of other interdependent functions). 

However, SAs are inherently incompatible with Principle 9 (money settlements). Principle 9 effectively provides that FMIs should use central bank money where practical and available or to otherwise use a settlement asset with little or no credit and liquidity risk that is readily convertible into central bank money or other liquid assets in both normal and stressed circumstances.

In SAs, a stablecoin is used as the settlement asset, so participants will be subject to the credit and liquidity risks of the stablecoin itself, the issuer of the stablecoin and the settlement institution. This may result in a greater amount of risk than “little to no” credit and liquidity risk and may not enable the SA and its participants to readily transfer their assets into other liquid assets, such as claims on a central bank. 

Stablecoins may be backed with underlying funds, securities or other assets (collectively, “reserve assets”). The funds received from SA participants can be, for example: (i) deposited at commercial banks; (ii) deposited at central banks; or (iii) invested in safe and liquid assets that will then be held at custodians. The manner and extent to which the reserve assets serve as backing depends on the design and associated contractual arrangements of the stablecoin in question as well as applicable law.

As a result, the proposed guidance sets out that systemic SAs should determine whether (i) the credit and liquidity risks of the stablecoin are minimised and strictly controlled and (ii) the stablecoin is an acceptable alternative to the use of central bank money. The guidance sets out a number of factors which CPMI/IOSCO consider to be relevant. Some of these are nearly impossible to satisfy in certain jurisdictions, such as the clarity and enforceability of the legal claims accorded to title, interests and other rights and protections accorded to holders of the stablecoin and SA participants in relation to the issuer and reserve assets backing it and the sufficiency of the regulatory and supervisory framework that applies to the issuer, reserve assets, custodian and reserve manager. However, we expect that where SAs become (or are at risk of becoming) systemically important, the legal and regulatory framework will also be adapted to make it feasible for this limb to be satisfied.  We look forward to seeing the commentary on the guidance to Principle 9 in particular.