About Steven Lofchie

Steven Lofchie is Senior Fellow of Legal Studies at the Center for Financial Stability and Co-chairman of the Financial Services Department at Cadwalader, Wickersham & Taft LLP.

Senate Banking Committee Considers Implications of Digital Assets for Illicit Finance

The Senate Committee on Banking, Housing, and Urban Affairs considered the implications of digital assets for illicit finance, terrorism, and other forms of criminal activity.

Statements

Senator Sherrod Brown, Chair of the Senate Banking Committee, emphasized crypto’s role as a tool used by criminals to facilitate ransomware attacks and finance terrorism. Senator Brown contrasted crypto with the dollar, stating that the latter “has safeguards to protect against crime and illicit activity” because companies that use real money are required to “know their customers, and report suspicious transactions.” Senator Brown argued that (i) “[c]rypto allows money launderers and terrorists to do things they never could have done with dollars,” and (ii) in the absence of the safeguards around dollars, “lax rules and little oversight” are giving criminals more opportunities to “hide and move money in the dark.”

Senator Brown also said that President Biden’s recent executive order on digital assets will “jumpstart a coordinated strategy from law enforcement and regulators to fight bad actors who want to use crypto.” He added that without such regulatory and law enforcement action “cybercriminals, rogue regimes [and] terrorists . . . [would] create a shadow financial system that works for them.”

Ranking Member Patrick J. Toomey’s emphasized the need for “regulatory clarity” with respect to digital assets. Senator Toomey argued that criminals have always “tried to utilize new technologies for nefarious gain . . . [b]ut that is not a reason to stifle new technological developments.” He went on to say that cryptocurrencies were being used both by Russia to evade sanctions and by Ukraine which raised over $100 million in donations.

Witness Testimony

Jonathan Levin, Co-Founder and Chief Strategy Officer of Chainalysis, Inc. emphasized that (i) “the transparency of blockchains enhances the ability of policymakers and law enforcement to detect, disrupt, and ultimately, deter illicit activity” and (ii) a financial system founded on the use of blockchain technology “can enhance the effectiveness of financial regulation more broadly.” He provided several short-term recommendations aimed at reducing the risk of sanctions evasion through digital assets, as well as long-term recommendations aimed at improving detection, disruption and deterrence of broader illicit uses of digital assets.

Mr. Levin’s short-term recommendations include:

  • authorities using digital asset wallet addresses as identifiers;
  • OFAC potentially sanctioning those digital asset exchanges and crypto entities that facilitate sanctions evasion; and
  • expanding information sharing.

His long-term recommendations include, among other things:

  • financial regulators and other law enforcement investing in “blockchain intelligence and analytics capabilities . . . that will enhance their ability to detect, disrupt, and deter illicit uses of digital assets”;
  • improving and promoting interagency coordination through the creation of a Virtual Asset Coordination Center; and
  • greater legal clarity over financial digital assets (e.g., commodities and securities).

Michael Mosier, Former Acting Director, Deputy Director/Digital Innovation Officer at FinCEN, stated that policymakers should focus not only on “chas[ing] bad actors,” but also on preventing exploitation of the vulnerable “from the start.” His recommendations include: (i) expanding the AML and Kleptocracy whistleblower programs to explicitly include “sanctions evasion and any violation of money laundering laws not just BSA violations”; (ii) providing the Kleptocracy Whistleblower Program with “dedicated funds and much higher caps” for those whistleblowers under autocratic regimes; and (iii) reducing global regulatory arbitrage, in part through Congress pressing U.S. FATF representatives to “focus on standardizing licensing across jurisdictions.”

Shane Stansbury, Senior Lecturing Fellow in Law and Robinson Everett Distinguished Fellow in the Center on Law, Ethics, and National Security at Duke University School of Law, detailed the challenges that cryptocurrency presents for law enforcement, including (i) deciphering who is responsible for the criminal activity, (ii) lack of regulation, and (iii) tracing digital assets. He stated that even with the latest blockchain analytics, “investigations can take years to complete.”

LOFCHIE COMMENTARY

While President Biden’s Executive Order on digital assets has been interpreted by some to reflect an open-mindedness on digital assets, recent statements by federal regulators and legislative representatives appears to be moving in a contrary direction – with Senator Brown’s statement being the most aggressively example. (See also Statement of SEC Commissioner LeeDOL Warns Plan Fiduciaries of the Substantial Risks of Cryptocurrency InvestmentsSEC Warns Investors of Risks Associated with Interest-Bearing Crypto Accounts.) Senator Brown echoed a phrase used to describe the Executive Order, saying that the “whole of government” must be put to the service of fighting the the problem of crypto. As to the Senate Banking Committee hearing, the “whole of government” is about amping up regulation.

One potentially interesting exception to the negative take on digital assets is the suggestion in the Executive Order that the Administration is open to considering the introduction of a USD-Central Bank Digital Currency. Perhaps the Administration considers private alternatives to a governmental CBDC as being undesirable and unwelcome competitors. A governmental CBDC, in which all transactions are ultimately routed through the banking system, could afford significant government transparency into spending.  

Email me about this

Primary Sources

  1. Senate Banking Committee Hearing: Understanding the Role of Digital Assets in Illicit Finance

President Biden Signs Executive Order on Digital Assets

President Joseph R. Biden signed an “Executive Order on Ensuring Responsible Development of Digital Assets,” which outlined a “first ever, whole-of-government approach” to address the risks and potential benefits of digital assets.

In an accompanying Fact Sheet, the White House identified seven key priorities:

  1. The protection of U.S. consumers, investors and businesses. The President directed Treasury to assess and develop “policy recommendations to address the implications of the growing digital asset sector and changes in financial markets for consumers, investors, and businesses, while promoting equitable economic growth.”
  2. The protection of U.S. financial stability and mitigation of systemic risk. The President directed the Financial Stability Oversight Council to “identify and mitigate systemic risks posed by digital assets and to develop recommendations to address any regulatory gaps.”
  3. The mitigation of illicit finance and national security risks. The President directed all relevant U.S. Government agencies to give an “unprecedented focus of coordinated action” in order to mitigate all risks associated with digital assets.
  4. The promotion of U.S. leadership in the global financial system. The President directed the Department of Commerce to establish a framework for Government agencies to use to promote U.S. technology and economic competitiveness.
  5. The promotion of equitable access to safe and affordable financial services. The President directed the Secretary of the Treasury to produce a report on digital money and payment systems that would include the “implications for economic growth, financial growth and inclusion,” including as to “the risk of disparate impact to communities who have a long standing history of insufficient access to safe and affordable financial services.”
  6. The support of the U.S. Government to ensure technological advances and the responsible development of digital assets. The President directed government agencies to take definitive steps to develop and implement digital asset systems while prioritizing the data privacy, security and exploitation of investors.
  7. The exploration of a U.S. Central Bank Digital Currency (“CBDC”). The President directed U.S. Government agencies to analyze the “technological infrastructure and capacity needs for a potential U.S. CBDC in a manner that protects Americans’ interests.”

Issuance of the Executive Order was accompanied by supportive statements from numerous senior U.S. government and regulatory officials including Treasury Secretary Janet Yellen; National Economic Council Director Brian Deese and National Security Advisor Jake Sullivan; Senate Banking Committee Chair Sherrod Brown; CFTC Chair Rostin Behnam; and CFPB Director Rohit Chopra.

LOFCHIE COMMENTARY

According to the Executive Order, digital assets have implications for climate change, financial growth, financial inclusion, illicit finance, international engagements, democratic values, global competitiveness, and much more. The Executive Order tells us that the United States must be a “global leader [in the] development and adoption of digital assets and related innovation” but we must also develop very substantial regulatory systems.

In light of the above, the President is requiring the involvement of at least eight different Cabinet members, numerous agencies, and every federal financial regulator, among others, to formulate policies. Given the sheer number of agencies to be involved, the complete diversity of interests to be considered, and the absence of any prioritization of those interests, the Executive Order does not actually provide much in the way of direction.  

While a possible interpretive theory is that this Executive Order will move the United States to develop a more digital-friendly regulatory system, it is equally possible that the Order signals very significant additional regulation. (See, e.g. SEC Commissioner Lee’s recent description of the digital asset industry as one that has grown by “largely def[ying] existing laws and regulations,” suggesting many new regulatory proposals to come.) Further, the Order’s frequent references to climate change may be understood as just “politics as usual,” or as many expect, a precursor to regulation on energy usage for mining.  

The Executive Order does seem to indicate federal movement toward the development of a Central Bank Digital Currency. Section 4 of the Executive Order is devoted to this topic and there are numerous other references to the issue throughout the Order. It would seem that some more specific proposal is likely imminent on this topic. 

Email me about this

Primary Sources

  1. Executive Order on Ensuring Responsible Development of Digital Assets
  2. FACT SHEET: President Biden to Sign Executive Order on Ensuring Responsible Development of Digital Assets
  3. White House Press Brief: Background Press Call by Senior Administration Officials on the President’s New Digital Assets Executive Order
  4. Statement by Secretary of the Treasury Janet L. Yellen on President Biden’s Executive Order on Digital Assets
  5. Statement by NEC Director Brian Deese and National Security Advisor Jake Sullivan on New Digital Assets Executive Order
  6. Brown Applauds President Biden’s Crypto Executive Order
  7. CFTC Public Statement: Statement of Chairman Rostin Behnam on the President’s Executive Order on Digital Assets
  8. CFPB Director Chopra Statement on President Biden’s Digital Assets Executive Order

SEC Chair Addresses Dynamic Regulation and Market Modernization

SEC Chair Gary Gensler urged regulators to update policy and monitor economic changes as part of a dynamic approach to regulation.

In prepared remarks before the Exchequer Club of Washington, D.C., Mr. Gensler highlighted two principles important to dynamic regulation: efficiency in capital markets and rules modernization.

On capital markets efficiency, Mr. Gensler noted the SEC’s role in promoting fair markets by lowering the costs of financial intermediation. He encouraged greater competition and transparency as key pillars of efficiency, and directed SEC staff to foster competition and transparency throughout the financial sector. Mr. Gensler hoped this focus on transparency and competition would help both issuers and investors.

With regard to modernization, Mr. Gensler described the SEC’s history of adapting to emergent technologies and emphasized the need for more dynamic regulation. While acknowledging cryptocurrency as one area of technological advancement, Mr. Gensler focused on artificial intelligence and predictive data analytics as potentially revolutionary developments for the SEC to watch closely in the coming decade. He also pointed to non-technological developments, such as special-purpose acquisition companies and direct listings, as important areas for the SEC’s consideration.

Mr. Gensler addressed public speculation on the timeline of new SEC rules publication by focusing on flexibility and “getting proposals right” rather than trying to prioritize any one area over another.

LOFCHIE COMMENTARY

Commissioner Gensler reports that in 1963, financial services accounted for 3.5% of the U.S. economy, while today it accounts for about 8%. He also cites to a 2014 study, which he describes as reporting that the “costs of financial intermediation . . . were as high in 2014 as they were in 1900.” The message behind these numbers is that financial services are too great a part of the economy with the implicit assumption that costs of financial services are effectively a tax or a drag on the U.S. economy. Mr. Gensler suggests that better (more?) dynamic regulation would serve to increase competition and drive down costs.

A different view on the role of financial services in the U.S. economy can be found on the U.S. government website, SelectUSA. According to that website, the financial services industry generated an export-import trade surplus of over $40 billion dollars and employed more than 6.3 million people. Further, the government site indicates that financial services also play a significant role in supporting the export of U.S. manufactured and agricultural products.

As to the costs of financial intermediation, without being able to access the 2014 article to which Mr. Gensler cites, it is common knowledge that the costs of trading U.S.-listed securities have dropped dramatically. New financial technologies, such as robo-advice and payment through the use of digital assets, may also substantially reduce the costs of financial transactions.

In short, a very high-level view of the numbers may not actually tell very much about the role that financial services should play in the economy, or as to whether that role is now too large, or could even be increased, given America’s position as banker to the world. While regulators should certainly be mindful of the costs of financial services and whether those costs are artificially high, it should be as important for regulators to be mindful of the costs and the impact of the regulations that they impose.

To take one example of the potential impact of regulatory costs, it is useful to take a look at another number: the number of futures commission merchants (“FCMs”) in the United States pre- and post-Dodd Frank. In January 2008, the CFTC shows that 151 firms filed financial reports as FCMs. In January 2021, the CFTC shows that 65 firms filed reports. This suggests some correlation between increasing regulation and a decrease in the number of competitor firms.

Email me about this.

Primary Sources

  1. SEC Chair Gary Gensler, Prepared Remarks: “Dynamic Regulation for a Dynamic Society” before the Exchequer Club of Washington, D.C.

SEC Proposes Amendments to Money Market Fund Rules

The SEC proposed amendments to the requirements applicable to money market funds pursuant to ICA Rule 2a-7 (“Money Market Funds”) under the Investment Company Act that are generally aimed at preventing a run on money market funds during a time of financial crisis. The amendments were proposed in light of the significant redemptions experienced by money market funds at the start of the COVID-19 pandemic.

Regulatory Changes
The proposed amendments include:

increasing the amount of assets with daily liquidity that a money market fund must hold from 10 percent to 25 percent of its assets; and increasing the amount of assets with weekly liquidity that a money market fund must hold from 30 percent of its assets to 50 percent; funds would be required to institute stress tests to determine their minimum level of desired liquidity; the SEC asks for comment as to what requirements should be imposed on a fund that fails to maintain its required liquidity level;

removing from the existing money market funds rule the authority of funds to impose either gates on redemption or to impose liquidity fees on redeeming investors (the SEC said that such authority was counterproductive encouraging investors to redeem before the gates or fees could be imposed);

requiring institutional prime and institutional tax-exempt money market funds to implement swing pricing, which would permit adjustments to current net asset value per share when the fund has net redemptions (and result in redeeming investors bearing liquidity costs);

modifying certain reporting requirements on Forms N-MFP and N-CR to improve the availability of money market fund information, and making conforming changes to Form N-1A to reflect proposed changes to the regulatory framework for these funds;

adding provisions to address how money market funds with stable net asset values should handle a negative interest rate environment;

adding provisions that specify how funds must calculate weighted average maturity and weighted average life; and

imposing additional reporting requirements on money market funds, including that a fund must file a report when it falls below a specified liquidity threshold.

Comments on the proposal are due within 45 days after its publication in the Federal Register.

Commissioner Statements
SEC Chair Gary Gensler supported the proposal, saying the reforms will help maintain “fair, orderly, and efficient markets.” SEC Commissioner Allison Herren Lee called the proposal a “necessary continuation of our focus on addressing weaknesses of these funds.” She added that, with respect to the public comment period, she would like to better understand the “foreseeable impacts of swing pricing” and how it might impact investor choice. SEC Commissioner Caroline A. Crenshaw stated that both the SEC and investors would be better positioned to “monitor funds’ activities and evaluate the impact of market stress on those funds.”

SEC Commissioner Hester M. Peirce opposed the proposal, saying that, as in the existing rule, there is “too much regulatory prescription and too little room for experimentation by funds.” Ms. Peirce said the proposal could “undermine the objective of making money market funds more resilient” and would “continue the trend of driving more money into government funds.” Ms. Peirce said, such an outcome would leave investors, issuers and markets worse off. Ms. Peirce was supportive of the reform to eliminate the connection between liquidity thresholds and fees and gates.

SEC Commissioner Elad L. Roisman supported some elements of the proposal, including the effort to explore several measures that could reduce run risk for money market funds. However, he dissented and expressed “strong reservations” about the requirement that a “uniform approach to charge fees to redeeming investors” would be applied to all institutional non-government money market funds (emphasis in original). Further, he found the timing of the comment period to be a “major shortcoming,” saying that he did not have confidence that market participants will be able to provide meaningful feedback over a comment period that aligns with several holidays and five other proposed rulemakings.

LOFCHIE COMMENTARY

There may be no area in securities law that is so conceptually difficult to create sound regulation as with respect to money market funds.  The central question is: how does one create a fund that maintains a fixed share value of $1, notwithstanding fluctuation in the value of the fund’s asset, and yet avoid having investors redeem when they believe that the true value of the fund is less than $1?  So far, mission not accomplished.  

Given the difficulty of the problem, Commissioner Peirce’s suggestion that the SEC should be less prescriptive and let different funds approach the problem differently makes sense.  After all, as the SEC concedes, the regulatory imposition of gates did not work.  Perhaps the SEC would do better to let the market experiment with solutions.

FRB Governor Randal Quarles Offers Parting Thoughts

Commentary by Steven Lofchie

Former Vice Chair for Supervision Randal K. Quarles covered a broad range of topics in his farewell remarks. He celebrated the overall strength of the banking system and suggested areas where there is latitude for regulatory change or recalibration.

“But I did at the time, and still do, have concerns about the possible precedents that have been created by the novel [credit] facilities that we [the Federal Reserve] created [as a reaction to the pandemic].”

Federal Reserve Board Vice Chair for Supervision Randal K. Quarles

Read his remarks, Between the Hither and the Farther Shore: Thoughts on Unfinished Business.

IMF Senior Executives Warn of Financial Stability Risks Posed by “Crypto Boom”

In an International Monetary Fund (“IMF”) blog post, IMF senior executives warned of the risks to financial stability from “cryptoization.”

The executives reported that the value of the crypto asset market increased tenfold from early 2020 to September 2021, even though many of the industry’s intermediary entities (e.g., miners and exchanges) lack “strong operational, governance, and risk practices.” They noted the substantial disruptions experienced by crypto exchanges during times of market turmoil, as well as a number of “high-profile” hacking incidents that resulted in stolen customer funds. While such incidents have not significantly affected financial stability, they argued, the crypto industry’s growth poses significant consumer protection risks.

In addition, the executives noted the money laundering, tax evasion and terrorist financing risks arising from the data gaps associated with the “(pseudo) anonymity” of crypto products. They stated that international regulatory collaboration is critical to crypto market regulation because the majority of crypto exchange transactions take place “through entities that operate primarily in offshore financial centers.” They also expressed concern regarding the risks to implementing monetary policy effectively that may result from the widespread use of cryptocurrencies.

To address issues arising from rapid crypto industry developments, the executives recommended that regulators (i) promptly take action to reduce data gaps, (ii) improve cross-border collaboration to reduce the risk of “regulatory arbitrage” and maximize supervision and enforcement efforts, (iii) implement current international standards that are applicable to crypto assets, including with respect to securities regulation, (iv) assess the benefits of adopting a central bank digital currency and (v) prioritize making cross-border payments more economical, efficient, transparent and widely available through the G20 Cross-Border Payments Roadmap.

LOFCHIE COMMENTARY

For all of the concerns that the U.S. and global regulators have expressed regarding digital assets, there has been disappointingly little focus on distinguishing among the different types of digital assets. A “trust” currency such as Bitcoin raises very different issues from a stablecoin that is fully supported by U.S. dollars in a U.S. bank (assuming, of course, that the dollars are there). These assets are different from digital assets that represent ownership of a company and likewise different from utility tokens. The resort to proclaiming that all of these assets should be regulated as securities has the benefit of simplicity, but it is not correct (at least under U.S. law), and it will make impossible a good number of the legal uses for which digital assets are well suited.

Senate Subcommittee Considers Benefits of a Central Bank Digital Currency

The U.S. Senate Banking Subcommittee on Economic Policy considered testimony on the benefits of issuing a central bank digital currency (“CBDC”).

Subcommittee Chair Senator Elizabeth Warren (D-MA) expressed support for a “well-designed” and “efficiently executed” CBDC because of its potential to “drive out bogus digital private money while improving financial inclusion, efficiency, and the safety of our financial system.” By contrast, Ms. Warren criticized cryptocurrencies, calling them a “fourth-rate alternative to real currency” and asserting that they are:

  • a “lousy” means of transacting, since their value substantially fluctuates as a result of speculative day trading;
  • a poor investment, given that there are currently no consumer protections for crypto investors, and pump-and-dump schemes “have become routine in crypto trading”;
  • substantial facilitators of illegal activity, as the secrecy component of cryptocurrencies has enabled criminals to more easily move money; and
  • “staggering” consumers of energy; she pointed to (i) the amount of energy required in “proof-of-work” mining for new cryptocurrency tokens, and (ii) the fact that Bitcoin-related energy consumption is higher than the yearly energy consumption of the Netherlands.

The Subcommittee heard testimony from the following individuals:

  • Dr. Neha Narula, MIT Digital Currency Initiative Director. Ms. Narula testified that a CBDC is not the only method for addressing the issues associated with underbanking in the traditional financial system, noting that a requirement on banks to provide free, no-minimum accounts to users might address the issue. Considering that the U.S. dollar plays a significant role in the global economy, Ms. Narula cautioned against too quickly adopting a U.S. CBDC without thoroughly determining (i) how it should be accessed and managed, and (ii) what data it makes visible, to whom and under what circumstances.
  • Lev Menand, Columbia Law School Academic Fellow and Lecturer in Law. Mr. Menand described shortcomings of the current U.S. banking system, including: (i) inaccessibility for certain U.S. households, (ii) the high cost of overdraft, deposit and minimum balance fees, (iii) slow processing times for check deposits, wire transfers and credit card payments, and (iv) complexity with respect to differing bank ledgers. Mr. Menand stated that the advent of a CBDC could address these shortcomings by, among other things, (i) expanding mainstream banking eligibility, (ii) decreasing the clearing time for payments, (iii) reducing the fees associated with banking, (iv) enhancing financial stability for businesses and institutions, and (v) decreasing regulatory complexity, considering that many of the regulations promulgated following the 2008 financial crisis were aimed at deposit substitutes.
  • Dr. Darrell Duffie, Stanford University Graduate School of Business Professor of Management and Finance. Mr. Duffie urged the United States to invest in the development of a CBDC, considering the progress that has been made internationally in similar ventures, particularly that of China’s eCNY. Mr. Duffie recommended that the United States (i) “take a leadership position” in international conversations regarding the cross-border use of CBDCs, and (ii) enhance the competitiveness and efficiency of the existing U.S. payment system.
  • J. Christopher Giancarlo, Willkie Farr & Gallagher Senior Counsel. Mr. Giancarlo promoted the Digital Dollar Project’s “champion model” proposal for a CBDC, which would involve the Federal Reserve issuing “Digital Dollars” to regulated banking entities. The former CFTC Commissioner stated that the champion model would enable the continuation of the two-tiered commercial bank and regulated money transmitter model through its deployment and recording of the Digital Dollar transition on a “new transactional infrastructure informed by distributed ledger technology.” Mr. Giancarlo asserted that the Digital Dollar would be “far superior” to Bitcoin with respect to environmental sustainability because it would not have to be mined. Rather, the Digital Dollar would be created by the Federal Reserve cryptographically and distributed electronically. Additionally, Mr. Giancarlo contended that the existence of a Digital Dollar during the earlier stages of the COVID-19 crisis would have provided a means of instant monetary relief to targeted beneficiaries. Mr. Giancarlo also noted that a Digital Dollar could be superior to competing financial instruments of foreign jurisdictions, particularly those with anti-democratic regimes that could use those instruments for surveillance purposes. He explained that it would be “in the best national interest of the United States and . . . in the interest of the world economy” to create a well-designed U.S. CBDC. One challenge, Mr. Giancarlo observed, is the ability of the United States to take a leadership role in the innovation of a CBDC, considering that “this global wave of digital currency innovation is quickly gaining momentum.”

LOFCHIE COMMENT

A U.S. dollar CBDC seems inevitable. When Senator Warren and former CFTC Chair Giancarlo agree on something, on anything, it is probably time to act. At what point does continuing to conduct studies create delays that may weaken the competitive position of the dollar in the global economy (or at least fail to capitalize on its strengths)?

PRIMARY SOURCES

  1. U.S. Senate Financial Services Subcommittee Hearing: Building a Stronger Financial System – Opportunities of a Central Bank Digital Currency
  2. Senator Elizabeth Warren Testimony: Building a Stronger Financial System – Opportunities of a Central Bank Digital Currency
  3. Neha Narula, MIT Digital Currency Initiative Testimony: Building a Stronger Financial System – Opportunities of a Central Bank Digital Currency
  4. Lev Menand, Columbia Law School Testimony: Building a Stronger Financial System – Opportunities of a Central Bank Digital Currency
  5. Darrell Duffie, Stanford Business School Testimony: Building a Stronger Financial System – Opportunities of a Central Bank Digital Currency
  6. J. Christopher Giancarlo, Willkie Farr & Gallagher Testimony: Building a Stronger Financial System – Opportunities of a Central Bank Digital Currency

House Passes Bill to Establish CFTC-SEC Digital Assets Working Group

The U.S. House of Representatives passed a bill that would direct the CFTC and SEC to jointly create a digital assets working group.

The bill would require that the working group include at least one individual representing each of the following groups: (i) financial technology firms providing digital assets products or services; (ii) financial firms within the jurisdiction of the SEC or the CFTC; (iii) institutions or organizations conducting academic research or engaging in advocacy efforts concerning the use of digital assets; (iv) small businesses using financial technology; (v) organizations concerned with investor protection; and (vi) institutions and organizations advocating for investment in historically underserved businesses.

Additionally, the bill would require that, within a year of its enactment, the working group must submit a report to the SEC, the CFTC and “relevant committees” that includes, among other things, an analysis of:

  • the United States’ legal and regulatory framework concerning digital assets, including the effect of (i) the ambiguity of the framework on primary and secondary digital assets markets, and (ii) domestic legal and regulatory digital assets regimes on the “competitive position of the United States”;
  • recommendations regarding (i) the implementation, maintenance and enhancement of primary and secondary digital assets markets, including the improvement of “fairness, orderliness, integrity, efficiency, transparency, availability and efficacy” of those markets, and (ii) standards for custody, private key management, cybersecurity and business continuity as it pertains to digital asset intermediaries; and
  • best practices to (i) decrease the prevalence of digital assets fraud and manipulation in cash, leveraged and derivatives markets, (ii) enhance investor protections for participants in such markets and (iii) aid in compliance with the Bank Secrecy Act’s AML anti-terrorism financing provisions.

LOFCHIE COMMENT

Why is it necessary to have the SEC and CFTC conduct a joint study, with each naming the same number of members? Would it not make more sense to empower one agency (generally the SEC) and direct it to consult with other agencies, including the CFTC and, for example, FinCEN, if AML is a topic of concern?

Second, explicit directions as to the members of the joint study detract from the efficacy of the study. Do the legislators believe that because one financial firm – subject to the regulation of the SEC – is included in the study, that firm can speak on behalf of all the other regulated financial firms?

Third, the topics seem to be a grab bag of wholly unrelated issues: is there some link between digital custody and historically underserved businesses where the same committee members will bring value to both discussions? If so, it is not obvious. If Congress wants both issues (or any of these issues) studied, it should direct the SEC to conduct the studies, and let the SEC figure out how to do so.

Primary Sources

  1. H.R. 1602: The “Eliminate Barriers to Innovation Act of 2021”

CRS Reviews Role of “Payment for Order Flow” in Debate over “Zero Commissions”

The Congressional Research Service (“CRS”) reviewed the role that “payment for order flow” (“PFOF”) plays in the “surge in retail investor securities trading at major discount broker-dealers.”

In its report, CRS described PFOF as a controversial rebate subsidizing the “non-existent commissions.” CRS stated that when broker-dealers do not pass the PFOF rebates onto clients, the economic incentives to send retail orders to rebating market-makers create potential conflicts of interest. CRS noted that this argument is why the United Kingdom has “effectively banned” PFOF.

Advocates for PFOF argue that investors benefit from the subsidized low or zero commission rates. Critics argue that PFOF raises conflicts-of-interest concerns over a brokers’ duty of best execution.

LOFCHIE COMMENT

While payment for order flow is a legitimate area for discussion, the more significant issue is why customers don’t use full-service brokers that provide them with some level of guidance. Congress and the SEC should consider whether over-regulation and the threat of enforcement actions are killing the business of full-service brokerage, leaving retail customers essentially on their own.

Unfortunately, asking the question as to whether regulation may be excessive or have unintended consequences is not a current priority. Rather, the tendency in response to any unusual event is to seek to adopt more regulations, as if more rules are always the panacea. Whether or not payment for order flow survives, the more significant reality is that retail investors are now effectively pushed to obtain their investment advice not from a regulated institution, but from a subreddit. See generally GameStop: Regulators Should Focus Less on “Solving the Problem”; More on “Improving the Situation.”

CFTC Advisory Committee Recommends Regulatory Actions to Address Climate Risk

A subcommittee of the CFTC Market Risk Advisory Committee (“MRAC”) recommended that U.S. regulators take action to address the risks that climate change poses to the U.S. financial system.

The recommendations came in a report, titled Managing Climate Risk in the U.S. Financial System, issued by the MRAC Climate-Related Market Risk Subcommittee. CFTC Commissioner Rostin Behnam, the sponsor of the MRAC, suggested the report could be used by “policymakers, regulators, and stakeholders” to begin a process of “taking thoughtful and intentional steps toward building a climate-resilient financial system that prepares our country for the decades to come.”

The report presents 53 recommendations to mitigate risks to financial markets posed by climate change and concludes, among other things, that:

climate change poses a “major risk to the stability of the U.S. financial system and to its ability to sustain the American economy”;

regulators “must” recognize that climate changes poses “serious emerging risks” and should move “urgently and decisively to measure, understand, and address these risks”;

existing law provides U.S. financial regulators with significant authority that could be used to begin addressing financial climate-related risk;

regulators can help promote the role of financial markets as providers of solutions to climate-related risks; and

financial innovation is required to manage climate risk and to facilitate the flow of capital in order to help “accelerate net-zero transition and increase economic opportunity.”

The report was approved 34-0 by the subcommittee’s membership. The CFTC also posted statements from participants on the subcommittee: (1) Cargill, (2) Citi, JP Morgan and Morgan Stanley, (3) CME Group, (4) ConocoPhillips and (5) Vanguard.

LOFCHIE COMMENTARY

The job of the CFTC is to regulate markets in which market participants can agree to transfer risk between them. If there exists a sufficient number of market participants to create a liquid market in which they can buy and sell “climate risk,” such risk would be measured by these participants. Then the CFTC should do its best to regulate that market so that it operates efficiently and transparently. It is not the job of the CFTC, as a regulatory agency, to advocate as to carbon taxes (either for or against), or for that matter, local insurance markets, corporate disclosures, or corporate governance. That job is entrusted to other regulators. When regulators pursue these other objectives, they deviate from their mission and their real task.

With the NFL football season now upon us, it is appropriate for the CFTC to consider the words of the greatest football coach of all time: “Do Your Job.”