SEC Rulemaking; Himes Amendment; "Mnuchin Rule" Reborn?

Good afternoon.

Thank you for subscribing to our new newsletter. We’ll provide updates on the DEF’s activities and policy developments that affect DeFi. At the outset of these updates, we’re going to alternate between US-focused content and EU/UK-focused content. Today’s update is focused on the US.

This is the first regular newsletter we’ve compiled, so please feel free to respond with advice and thoughts on what is and isn’t helpful. We want to make it as useful to the community as possible and will experiment with different approaches going forward.

SEC Proposed Rulemaking Could Implicate DeFi. We’re Mounting a Response.

The Securities and Exchange Commission (SEC) issued a new notice of proposed rulemaking (NPRM) purportedly to “include significant treasury markets platforms within regulation ATS.” The “proposal would enhance investor protections and cybersecurity for alternative trading systems that trade treasuries and other government securities,” the SEC’s press release explains.

Several folks have made compelling arguments that this NPRM affects DeFi, and we agree with them. And even if the NPRM wasn’t related to or intended to target DeFi before, DeFi’s a part of the conversation now.

Here’s to hoping we’ll be proven wrong, but right now it appears like a federal agency is attempting to newly regulate completely novel software under the guise of including “significant treasury markets platforms within regulation ATS.”

That’s why we’re taking action.

What’s Next: First, we’re hiring counsel to figure out precisely what in the rulemaking would and/or could implicate DeFi and how. There’s a lot in those 654 pages, and we don’t want to miss anything. Second, we’re raising awareness of this issue among lawmakers interested in DeFi. Finally, we’ll submit our comment letter in response to the NPRM itself while laying the groundwork for a longer term response. We’ll keep you updated as our response progresses.

America COMPETES Act Himes Amendment: Notice and Comment Restored.

In brief: The crypto lobby notched a meaningful victory this week on a proposal that would have granted the Department of the Treasury vast emergency powers—applicable to financial institutions (FIs) like custodial crypto exchanges—that could have been exercised without public scrutiny. Those new powers could have been used to, for example, restrict or even outright ban custodial crypto businesses’ interactions with self-hosted wallets.

With the changes to the Himes amendment, those new powers remain in the legislation, but the notice and comment requirement to exercise those powers will be retained. This will make sure that these powers aren’t exercised without public comment and scrutiny.

Details: In a nutshell, the federal government can restrict US financial institutions’ activities with respect to transactions/institutions/jurisdictions the government deems to be of “primary money laundering concern.” Under current law, the Treasury must engage in public notice and comment before implementing these special measures.

As part of legislation intended to bolster the US’s competitiveness, Rep. Jim Himes (D-CT) proposed an amendment to expand these powers. The Himes amendment adds a new “special measure” that grants the Treasury the power to restrict US FI’s “transmittals of funds” involving activities it deems to be of “primary money laundering concern,” and the amendment would have allowed these restrictions to be implemented without notice and comment.

“Transmittals of funds” isn’t defined—the amendment delegates that authority to the Treasury itself—but in a sense every financial activity involves some movement of value.

After pushback on this amendment, Himes changed the provision such that the new “special measure” related to restrictions on transmittals of funds remains in the legislation, but the notice and comment requirement will remain.

It’s difficult to know what the exercising of this power might look like in practice, but it could go something like this: (1) transactions involving Cryptocurrency X are deemed to be of “primary money laundering concern.” (2) Treasury initiates a notice and comment period to implement a “special measure” restricting US FI’s ability to conduct “transmittals of funds” involving Cryptocurrency X. (3) Notice and comment ends, the “special measure” is adopted, and US FIs (e.g. custodial crypto exchanges) can no longer conduct transmittals involving Cryptocurrency X. This means (again, just a hypothetical) US FIs could be prohibited from allowing withdrawals to self-custody or transmittals of Cryptocurrency X to another exchange.

We are thankful to Rep. Himes for his quick action to rectify the amendment’s removal of notice and comment with respect to these sweeping powers. Unlike other emergency powers like sanctions, these “special measures” target categories of activities as opposed to individuals, meaning their potential effects are far broader.

What’s Next: We believe that this new “special measure” is uniquely powerful and broad, and it’s worth exploring alternatives that accomplish the Treasury’s AML/CFT objectives in a more tailored way. As the bill moves through the House and the Senate, the DEF plans to continue making this argument to lawmakers. We will fight for changes to the final bill that will better define the scope of Treasury’s power.

The Proposed “Mnuchin Rule” May Be Back—But Don’t Worry Yet.

The Department of Treasury announced that a rule that would require banks and money service businesses to “submit reports, keep records, and verify the identity of customers” that transact with digital assets “held in unhosted wallets” is in “Final Rule Stage” for potential consideration in September. Among other things, this rule would require custodial cryptocurrency exchanges to KYC their customers’ counter-parties, a novel and expansive requirement when it comes to financial surveillance requirements.

But don’t worry yet: just because something’s on the agenda doesn’t mean it’s going to happen. Agencies often, for a variety of reasons, keep outstanding rulemakings on their agendas, sometimes for many years.

Crypto regulatory watchers will remember this proposed rule as outgoing Treasury Secretary Steven Mnuchin’s surprise “Christmas gift” to the crypto ecosystem in late December 2020 at the tail-end of the Trump Administration.

While we’re not worried about the return of the Mnuchin rule at this time, we think it’s worth noting that the Himes Amendment’s new “special measure” could potentially be used to accomplish the same or a similar outcome as the Mnuchin rulemaking would. For example, crypto transactions could be deemed to be of “primary money laundering concern,” and the Treasury could propose a “special measure” requiring that US FIs effectuating “transmittals of funds” involving digital assets “held in unhosted wallets” would have to KYC their customers’ counter-parties.

What’s next? We’re not too concerned yet — but that doesn’t mean we won’t be watching this closely.