When 11 spot Bitcoin ETFs launched last month, not one of them had a bank as custodian for the underlying crypto. A big factor in this is the SEC’s Staff Accounting Bulletin (SAB) 121 relating to the custody of cryptocurrencies. It makes providing crypto custody services prohibitively expensive for banks. In late October 2023, the Government Accountability Office (GAO) ruled that SAB 121 should have been subject to Congressional review. Now lawmakers in both the House and the Senate have taken formal steps to reverse the rule.
The vast majority of Bitcoin ETF crypto is custodied by Coinbase. Many believe this is far too concentrated and not helpful for consumer protection. Custodial banks have far higher budgets to deal with cybersecurity. Consider if a bank held the Bitcoin in custody for the BlackRock spot Bitcoin ETF (iBIT), which has $2.85 billion in assets. A bank custodian would have to set aside $2.85 billion in capital. That’s clearly not viable.
“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,” said Senator Lummis. “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.”
Two regulatory steps
Firstly, Congressmen Mike Flood and Wiley Nickel introduced a resolution under the Congressional Review Act stating that the rule would have no force or effect. Secondly, the Congressmen introduced a Bill, the Uniform Treatment of Custodial Assets Act, aiming to prevent banks from needing to treat assets under custody as a liability. It also blocks the imposition of additional capital requirements on banks because they provide custody services for crypto-assets. Senator Cynthia Lummis also supports the Bill.
“The SEC’s Staff Accounting Bulletin 121 represents a significant departure from longstanding accounting treatment for custodied assets and threatens the banking industry’s ability to provide its customers with safe and sound custody of digital assets,” said the American Bankers Association. “Limiting banks’ ability to offer these services leaves consumers with few well-regulated, trusted options for their digital asset portfolios and ultimately exposes them to risk.”
The Bank Policy Institute, Financial Services Forum and SIFMA also supported the legislator’s moves.
Why SAB 121 is such a problem
SAB 121 rule forces all listed companies, not just banks, to disclose crypto-assets under custody as both an asset and a liability on the balance sheet. The accounting convention is that the assets under custody don’t belong to the company, so they should not appear on the balance sheet. SAB 121 has a major impact on banks because they are subject to capital requirements based on their balance sheet. In effect, the rule means U.S. banks must keep a dollar of capital for every dollar of assets under custody. If this rule were applied to all assets, it would require BNY Mellon to have $48 trillion in capital.
The Basel Committee, the international body that sets bank capital and liquidity rules, does not suggest this accounting treatment. When it introduced its rules for crypto-assets in late 2022, it explicitly stated it didn’t expect the assets to appear on the balance sheet. However, there were some risk-related caveats.
Banks have pushed back hard against the rule. The former head of State Street Digital, Nadine Chakar, called SAB 121 ‘insane.’ State Street Digital recently did a schedule restructuring. However, it also laid off some staff shortly after the launch of the ETFs.
During a Congressional hearing, the Chair of the Federal Reserve, Jerome Powell, acknowledged the SAB 121 treatment is unconventional.
In November, lawmakers wrote to the Federal Reserve and Office of the Comptroller of the Currency (OCC), urging them to ignore SAB 121.