Yesterday the House of Representatives failed to overturn a Presidential veto relating to SAB 121, an SEC accounting rule that prevents banks from providing digital asset custody. While a majority voted in favor, 228 versus 184, it requires two thirds to override a presidential veto. Hence, the SEC accounting rule still stands. However, on Wednesday Representative Maxine Waters said the SEC was considering changes to address bank concerns.
According to Ms Waters, the ranking Democrat on the House Financial Services Committee, the SEC may be close to an agreement on modifications with custody banks, “which would ensure that well-regulated entities like custody banks can offer crypto custody services consistent with SAB 121”. This was news to Patrick McHenry, the Chair of the same committee.
The crux of the problem is the accounting rule forces assets under custody to be disclosed as both an asset and liability on the balance sheet, contrary to accounting convention.
This expands the size of the balance sheet on which banks have their capital requirements assessed. Hence, providing crypto custody would require banks to set aside large amounts of capital, making it prohibitively expensive.
Banking industry bodies previously proposed moving disclosures to the notes. Failing that, they suggested narrowing the definition of crypto-assets to only cover cryptocurrencies. This would allow them to participate in tokenization efforts. There’s a possibility any amendments the SEC is considering will be along these lines.
SAB 121 has dragged on
The saga has taken up a considerable legislator time. In May both the House (228 v 182) and Senate (60 v 38) voted in favor of a resolution to cancel SAB 121, followed by a Presidential veto. Last year the Government Accountability Office (GAO) ruled that SAB 121 was a rule that should have received Congressional approval. Plus, legislators wrote to bank regulators about SAB 121 multiple times.
In March 2022 the SEC published SAB 121, apparently without consulting banking regulators. The rule impacts all listed firms, not just banks. However, if the potential impact on banks was immediately obvious to journalists, it’s odd that the SEC didn’t consider it.
The issue is bigger than cryptocurrency. It’s widely believed that tokenization – of securities, funds and other real world assets – will see the rewiring of the financial system. The Bank of International Settlements, the central bank of central banks, frowns on crypto but is making a big push on tokenization.
In order for tokenization to progress in an institutional framework, it’s essential for assets to be held in custody by banks. The world’s largest custodian banks are American. BNY Mellon, State Street, JP Morgan, Citi and Northern Trust provide custody for $160 trillion in assets.
While the United States prides itself on its sophisticated markets, institutional work on tokenization is happening elsewhere.
For example, in Brazil, the central bank plans to roll out an interbank CBDC to support tokenization efforts. In Singapore, 24 institutions are taking part in the Project Guardian tokenization sandbox. The ECB recently announced 48 institutions for the second wave of its DLT settlement trials. Plus, the UK is launching the Digital Securities Sandbox.
Several U.S. firms are involved in the Singapore and European work. Resolving the custody issue could see a significant acceleration in activity on home soil.
