The crypto market has been tense over the past few weeks because of the U.S. legislature’s action against SEC’s controversial SAB 121. This directive has become a significant barrier because of its stringent accounting and disclosure requirements, preventing banks from serving as custodians for digital assets.
What Is SAB 121?
Staff Accounting Bulletin No.121 (SAB 121) is a directive issued by the SEC to address the accounting and disclosure obligations of entities that safeguard cryptocurrency assets. It was introduced in March 2022 and provides guidance for a reporting entity’s operating platform that enables user transactions in crypto-assets and is responsible for safeguarding customer crypto assets. Some of the key points of SAB 121 include,
- It applies to all entities filing financial information with the SEC under U.S. GAAP or IFRS(International Financial Reporting Standards), including those filing reports under the Securities Exchange Act of 1934 and entities involved in IPO.
- Entities with safeguarding obligations must recognize a liability and a corresponding safeguarding asset on their balance sheets, measured at the fair value of the crypto assets. This is done to reflect the responsibility and potential risks associated with safeguarding digital assets.
- SAB requires comprehensive disclosure regarding the nature and amount of safeguarded crypto assets, the vulnerabilities and risks involved, fair value measurements, and the specific responsibilities of the entity in safeguarding these assets. This also includes who holds the cryptographic keys and how assets are protected from loss or theft.
The Beginning of Controversy
In October 2023, the Government Accountability Office (GAO) said that the SEC was out of bounds when it issued its controversial Staff Accounting Bulletin 121 and that Congress should have had a chance to review it. The SAB 121 threatens crypto investors’ ability to find safe harbors for their assets. It should have gone through a different process, including submission to Congress, before taking effect.
Republican U.S. lawmakers argue that SAB 121’s requirement for financial institutions to record crypto assets on their balance sheets and maintain capital against them has deterred banks from acting as crypto custodians. For instance, consider a bank-held Bitcoin in custody for the GBTC (Grayscale Bitcoin Trust), which has a value of $2.5 billion in assets. Then, the bank custodian would have to set $2.5 billion aside as liability.
According to GAO, “We find that the bulletin does meet the definition of a rule under [the Administrative Procedure Act] and that no exception applies. Thus, the bulletin is subject to [the Congressional Review Act’s] submission requirement.”
Hester M. Peirce, an SEC commissioner, also objected to the SEC’s decision on the bulletin, saying that it was a scattershot and inefficient approach to crypto. She added that the SAB does not acknowledge the Commission’s role in creating the legal and regulatory risks that justify this accounting treatment. Despite many pleas over many years, the Commission has refused to provide regulatory guidance about how our rules apply to crypto-assets, so some of the responsibility for the lack of legal and regulatory clarity lies at our doorstep. Senator Lummis said,
SAB 121 has massive implications, and the SEC should have received feedback on it from the federal banking regulators and the public before implementing this legally binding directive. I have serious concerns over the impact of this bulletin on consumer protection and ensuring well-regulated financial institutions are able to provide safe custody for Americans’ hard-earned financial assets.
Regulatory Measures
On September 14, 2023, Congressmen Mike Flood and Wiley Nickel introduced a bill, the Uniform Treatment of Assets Act, which aims to prevent banks from treating assets under custody as liabilities. Furthermore, it blocks banks’ imposition of additional capital requirements because they provide custody services for crypto assets. In addition, Congressmen introduced a resolution under the Congressional Review Act stating the rule would have no force or effect.
Impact of SAB 121 on Digital Asset Products and Services
On February 14, 2024, The American Bankers Association (ABA), the Bank Policy Institute, and other associations sent a joint letter to SEC Chair Gary Gensler. They requested targeted adjustments to SAB 121 to address the challenges it poses to the banking organizations. The examples of these challenges include,
- The SEC recently approved Spot Bitcoin Exchange Traded Products (ETPs), granting investors access to this asset class through regulated means. However, banks are notably absent as custodians for these ETPs, a role normally performed for most other ETPs. Due to SAB 121’s impact on Tire 1 capital ratios and other reserve requirements, it is nearly impossible for banks to serve as custodians at scale. This exclusion raises safety and stability concerns as a single nonbank entity now holds custody for most of these ETPs, increasing centralization risks. By allowing carefully regulated banks to provide custodial services could mitigate this risk.
- Banking Organizations are increasingly adopting Distributed Ledger Technology (DLT) to record traditional financial assets like bonds, which can streamline payment, clearing, reconciliation, and settlement processes. However, SAB 121 poses a barrier due to its broad definition of “crypto asset,” encompassing any digital asset issued or transferred via DLT. This includes traditional financial assets, potentially subjecting them to SAB 121’s stringent requirements despite their differing risk profiles. Unlike cryptocurrencies like Bitcoin on public networks, traditional financial instruments on controlled DLT networks can have transactions amended or canceled, presenting lower risks. The crypto market’s volatility, unrelated to banks’ use of permissioned DLT, highlights this distinction. Clarifying that DLT-based traditional financial assets fall outside SAB 121’s scope would address these challenges and support innovation in banking.
The targeted modifications requested by the various associations include,
- Exempting banking organizations that are subject to robust oversight by federal banking agencies from on-balance sheet treatment.
- Narrowing the definition of “crypto-assets” to clarify and confirm the exclusion of certain asset types and use cases.
Resolution to Overturn SAB 121
On May 8, 2024, the House of Representatives voted in favor of a resolution opposing the SEC’s accounting policy, H.J.Res.109, SAB 121. Since its arrival, SAB 121 has been the center of controversy and criticism from Republican lawmakers and businesses. The bulletin’s real purpose was to clarify the accounting treatment of crypto assets, but because the policy guidance has been handled badly, it has resulted in a different outcome. Congressman Mike Flood, in an interview, said Gary Gensler, in his jihad against assets, used what was supposed to be mundane staff accounting guidance to essentially freeze out large publicly traded banks from taking custody of digital assets.
On the day of the voting, President Biden’s office issued a statement saying that he would veto H.R.109 if the file reached his desk.
SAB 121 was issued in response to demonstrated technological, legal, and regulatory risks that have caused substantial losses to consumers. By virtue of invoking the Congressional Review Act, it could also inappropriately constrain the SEC’s ability to ensure appropriate guardrails and address future issues related to crypto-assets including financial stability. Limiting the SEC’s ability to maintain a comprehensive and effective financial regulatory framework for crypto-assets would introduce substantial financial instability and market uncertainty.
Despite the president’s statement, the House of Representatives voted in favor and passed the resolution to the Senate. The Senate also voted in favor of the resolution on May 17, 2024. Now, the resolution is in the hands of the President and has a 10-day deadline, excluding Sundays. The President has to make a final decision before June 3.
Conclusion
The legislative efforts to overturn the SEC’s SAB 121 and address significant challenges faced by banks in providing crypto custody services. SAB 121’s broad definition of “crypto-assets” and stringent accounting requirements have hindered banks’ involvement, raising concentration risk and stifling innovation in financial technologies like DLT. The Uniform Treatment of Assets Act and a Congressional resolution seek to exempt regulated banks and clarify asset definitions, promoting safer and more efficient crypto custody solutions. As the resolution awaits President Biden’s decision, the outcome will significantly impact the future of banking and digital asset regulation.
