There are many reasons why a bank might choose not to accept custody of crypto assets.
With the approval of 11 spot Bitcoin exchange-traded products by the U.S. Securities and Exchange Commission on January 10, 2024, and the surprise approval of rule changes on May 23, 2024, allowing for spot Ether ETPs, it may seem a bit odd that none of the ETP custodians so far is a bank. Banks maintain custody of a variety of financial assets for customers. In addition, coming changes to the Uniform Commercial Code facilitate lending against crypto assets as long as a lender obtains the cryptographic keys to the crypto.
There are many reasons why a bank might choose not to accept custody of crypto assets. One significant hurdle for those that might otherwise want to is SEC Staff Accounting Bulletin No. 121. The SEC may not be the first regulator that comes to mind when thinking about a bank. However, many banks have publicly traded stock or otherwise have outstanding equity securities that subject them to the reporting requirements of the Securities Exchange Act of 1934. Such SEC requirements have been enforced by the Office of the Comptroller of the Currency, a more typical bank regulator.
SAB 121 was issued on March 31, 2022, and provides "interpretive guidance for entities to consider when they have obligations to safeguard crypto-assets held for their platform users." Noting the technological, legal and regulatory risks that crypto-assets can pose to the operations and financial condition of a custodian, it states that crypto should be reported both as an asset and as a liability on a custodian's balance sheet at the fair market value of the crypto as of acquiring the cryptographic keys and at each reporting date.
Since the asset and liability cancel each other out, it might appear that there is no harm from the rule. However, the ramifications can be prohibitively expensive for a bank. Regulated banks are subject to minimum capital requirements to manage investment risk and prevent a collapse if there is financial stress and a run on the bank. Assets under custody are usually not included on a custodian's balance sheet since they belong to the customers. Correspondingly, the final Basel III rules relating to capital requirements for crypto assets were revised to clarify that such assets under custody are generally not subject to the liquidity risk requirements. To reserve capital on the balance sheet for each dollar of crypto assets held in custody when similar assets such as securities are not subject to this rule can limit a bank from growing a significant crypto custody business.
SAB 121 has not gone unnoticed in the banking community. Several major banks have put crypto custody plans on hold. On a broader industry level, the Securities Industry and Financial Markets Association and the American Bankers Association sent a joint letter to the SEC on June 22, 2022, outlining mitigating factors applicable to banks that already address the risks covered by SAB 121. Moreover, the OCC, the Federal Deposit Insurance Corporation, the Federal Reserve Board and the National Credit Union Association exercise broad regulatory and supervisory powers over banks and credit unions.
More recently, the discussion over SAB 121 has been taken up in Congress. On October 31, 2023, the U.S. Government Accountability Office determined that SAB 121 is an agency rule for purposes of the Congressional Review Act and the Administrative Procedures Act. Although the SEC asserted that SAB 121 is just interpretive guidance, the GAO said it met the standard for being a rule since it is "an agency statement of general or particular applicability and future effect designed to implement, interpret or prescribe law or policy or describing the organization, procedure, or practice requirements of an agency." Under the Congressional Review Act, a report on each rule must be submitted by an agency to the House of Representatives, the Senate and the comptroller general.
Based on the GAO decision, a bipartisan group of senators and members of Congress sent a letter on November 15, 2023, to the FDIC, the FRB, the OCC and the NCUA asking them to clarify that SAB 121 is not enforceable. Taking more direct action, members of the House introduced H.J. Res 109 on February 1, 2024, providing for congressional disapproval of SAB 121. After passing the House on May 8 in a 228-182 vote, H.J.Res 109 was passed by the Senate a few days later on May 16 by a 60-38 vote. However, on the same day the House passed the resolution, the Executive Office of the President issued a statement that the president would veto it, citing the SEC's "work to protect investors in the crypto-asset markets and to safeguard the broader financial system." On May 31, the resolution was formally vetoed.
On June 3, the House tabled further action on the resolution until July 10. Although the resolution passed by wide margins, neither chamber passed it by the two-thirds vote necessary to override the veto. With the future of crypto custody by banks at stake, this is likely not the last to be heard on SAB 121.
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