SAB 121’s Impact on Crypto Custody: What CFOs Need to Know
SAB 121, issued by the SEC, mandates that entities safeguarding crypto assets recognize these assets and corresponding liabilities on their balance sheets, significantly impacting digital asset custodians, particularly banks. Recent legislative efforts to overturn SAB 121 have sparked debates on regulatory overreach and the future of crypto custody regulations, with President Biden's potential veto playing a critical role in the outcome.
TL;DR
The SEC's SAB 121 mandates that entities safeguarding crypto assets must recognize these assets and corresponding liabilities on their balance sheets and provide extensive disclosures, significantly impacting digital asset custodians.
In May 2024, the U.S. House of Representatives passed a resolution to overturn SAB 121, citing its detrimental effects on banks' ability to provide crypto custody services, but President Biden has threatened to veto the resolution.
Overturning SAB 121 would remove barriers for banks and regulated institutions to offer crypto custody services at scale, potentially spurring wider institutional adoption and integration of crypto into traditional finance.
What is SAB 121?
SAB (Staff Accounting Bulletin) 121 was issued by the U.S. Securities and Exchange Commission (SEC) in March 2022, providing guidance on how entities should account for their obligations to safeguard crypto assets held for others. This bulletin has significant implications for digital asset custodians and has sparked intense debate within the crypto and banking industries.
The key requirements of SAB 121 are:
Entities safeguarding crypto assets for others must recognize both an asset and a corresponding liability on their balance sheets for the custodied crypto assets.
The asset and liability are initially and subsequently measured at the fair value of the custodied crypto assets.
Extensive disclosures are required about the nature, amount, risks, and fair value measurement of the custodied crypto assets
Did the government overturn SAB 121?
In May 2024, the U.S. House of Representatives passed a resolution to overturn SAB 121, citing the SEC's lack of proper oversight and the bulletin's detrimental impact on banks' ability to provide crypto custody services. However, President Biden has vowed to veto the resolution, setting up a potential showdown between the executive and legislative branches.
The debate surrounding SAB 121 highlights the broader challenges of regulating the rapidly evolving crypto industry and the need for clear, well-defined rules that balance investor protection with innovation and financial stability. As the crypto ecosystem continues to grow, the resolution of the SAB 121 controversy could set important precedents for future regulatory actions.
With the House and Senate voting to overturn the SEC's Staff Accounting Bulletin (SAB) 121, the decision now rests with President Biden on whether to sign the resolution into law or veto it. Here are some potential scenarios:
The President could choose to veto the resolution, siding with the SEC and allowing SAB 121 to remain in effect. This would align with his administration's earlier stance of supporting SAB 121 as a measure to enhance transparency around crypto custody risks. However, a veto would likely face significant backlash from the bipartisan coalition in Congress that voted to overturn the rule.
Alternatively, Biden could sign the resolution, nullifying SAB 121 and preventing the SEC from issuing similar guidance in the future. This would be a win for the crypto industry and banks that argued SAB 121 imposed excessive costs and capital requirements, stifling their ability to offer crypto custody services.
A third option is for the President to take no action and allow the 10-day window to lapse without signing or vetoing. If Congress remains in pro-forma sessions, the resolution would become law. However, if Congress adjourns, it could potentially trigger a pocket veto.
Regardless of the outcome, the SAB 121 saga has reignited debates around regulatory overreach, the balance of power between Congress and federal agencies, and the need for clear, tailored crypto regulations. The President's decision will not only impact the crypto custody landscape but could also set important precedents for future legislative-executive dynamics on digital asset policies
Impact on Digital Asset Custodians
The requirement to reflect custodied crypto assets on balance sheets departs from the traditional off-balance sheet treatment for custodied assets. This has a profound impact on digital asset custodians, particularly banks, as it increases their regulatory capital requirements and operational costs.
If the recent resolution to overturn SAB 121 is vetoed by the President, crypto CFOs can expect the following:
Increase in Regulatory Capital
For crypto firms that are banks or bank holding companies, reflecting custodied crypto assets on the balance sheet will substantially increase the regulatory capital they must hold against those assets.
This makes it economically unviable for banks to provide crypto custody services at scale due to the high costs of raising additional capital
Non-bank crypto custodians may also face higher costs to meet the accounting and disclosure requirements
Additional Disclosures
Extensive disclosures will be required on the nature, amount, risks, vulnerabilities, and fair value measurement of custodied crypto assets
Disclosures may also be needed outside the financial statements, such as in MD&A sections
Crypto CFOs who fail to comply with SAB 121 could face several potential risks and consequences:
Regulatory Scrutiny and Enforcement
Non-compliance with SAB 121 could lead to scrutiny and enforcement actions from the SEC for inadequate financial reporting and disclosures
The SEC may impose fines, require restatements, or take other punitive measures against non-compliant entities
Investor Lawsuits
Failure to properly recognize custodied crypto assets and associated risks could be viewed as misleading investors
This opens up crypto firms to potential lawsuits from investors for material omissions or misstatements in financial report
Regulatory Capital Issues for Banks
For banks, not reflecting custodied crypto assets on the balance sheet as required by SAB 121 could artificially lower their regulatory capital requirements
This raises prudential concerns for regulators about adequate capitalization of crypto custody activities
RELATED STORIES
What are the implications of the House of Representatives overturning SAB 121?
Overturning SAB 121 removes a major barrier preventing banks and other regulated financial institutions from offering crypto custody services at scale. Without this rule, they can provide off-balance sheet custody, enabling wider institutional adoption and integration of crypto into traditional finance.
The bipartisan support to overturn SAB 121 signals a growing consensus across the aisle that the existing regulatory landscape is inadequate for the crypto industry. This acknowledgment could spur efforts to establish a comprehensive, tailored regulatory framework that provides clarity and fosters innovation while protecting investors.
Some view the SAB 121 vote as a positive sign that bipartisan crypto legislation, such as stablecoin bills, may be achievable. While the White House's veto threat casts doubt, the bipartisan collaboration on SAB 121 could lay the groundwork for future legislative compromises on crypto regulation.
Proponents argue that overturning SAB 121 enables regulated custodians like banks to safeguard crypto assets, improving protections for investors and driving innovation in custody solutions. This could enhance confidence in the crypto ecosystem and accelerate mainstream adoption.
However, the impact of overturning SAB 121 hinges on several factors, including the Senate vote, potential presidential veto, and whether it catalyzes further legislative action. Nonetheless, the House vote signals a growing willingness among lawmakers to address the regulatory challenges surrounding crypto, which could drive progress in establishing a clear and supportive regulatory environment for the industry's growth and maturation.
Biden's response to FIT21 gives custodians hope
President Biden's decision not to threaten a veto against the Financial Innovation and Technology for the 21st Century Act (Fit 21) is a significant shift, signaling a more collaborative approach towards crypto regulation. This change contrasts with the administration's previous firm stance against similar measures, reflecting a potential openness to working with Congress on future crypto market legislation. The new stance suggests a willingness to address industry concerns and develop a tailored regulatory framework, which could alleviate some of the operational and compliance pressures on digital asset custodians. Ultimately, this could foster innovation and growth within the crypto industry, providing more clarity and stability for custodians.
Frequently Asked Questions
What is SAB 121 and why is it significant for crypto custodians?
SAB 121 is a guidance issued by the SEC that requires entities safeguarding crypto assets to recognize these assets and corresponding liabilities on their balance sheets. This has major implications for digital asset custodians, increasing regulatory capital requirements and operational costs.
What are the potential consequences if SAB 121 remains in effect?
If SAB 121 remains in effect, crypto custodians, especially banks, will face higher regulatory capital requirements and extensive disclosure obligations. This could make it economically challenging for banks to offer crypto custody services at scale and increase operational costs for non-bank custodians.
Why does the overturning SAB 121 matter?
Overturning SAB 121 would remove significant barriers for banks and regulated financial institutions, enabling them to offer off-balance sheet crypto custody services. This could facilitate wider institutional adoption and integration of crypto into traditional finance, potentially driving innovation and enhancing investor protection.
