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The underlying cryptocurrency was not held by a bank for any of the 11 Bitcoin ETFs that launched last month. SEC Staff Accounting Bulletin (SAB) 121, which pertains to the custody of cryptocurrencies, is a significant contributor to this scenario. Banks find it prohibitively expensive to provide crypto custody services. In late October 2023, the Government Accountability Office (GAO) ruled that SAB 121 should have been subject to Congressional review. The rule is being reversed by lawmakers in both houses and senates through formal action.
Coinbase is the sole owner of a significant amount of Bitcoin and Ethereum ETH cryptocurrencies. There are many who think that this is too concentrated and does little to protect consumers. Custodial banks allocate a significant portion of their budget to cybersecurity initiatives. Consider if a bank held the Bitcoin in custody for the BlackRock spot Bitcoin ETF (iBIT), which has $2.85 billion in assets. Setting aside $2.85 billion in capital is a requirement for a bank custodian. It's obvious that that isn't possible.
According to Senator Lummis, SAB 121 has significant implications that warrant the SEC's review from federal banking regulators and the public before implementing it as a legally binding directive. This bulletin's impact on consumer protection and ensuring that well-regulated financial institutions can safely hold Americans' hard-earned financial assets is something I have serious concerns about.”
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. The provision of custody services for crypto-assets by banks does not result in them being subject to additional capital requirements. The Bill is also supported by Senator Cynthia Lummis.
The American Bankers Association's statement states that the banking industry can't ensure the safe and sound custody of digital assets due to a significant deviation in longstanding accounting treatment for custodied assets, resulting in a significant departure from the SEC's Staff Accounting Bulletin 121. Consumers are left with limited well-regulated and trusted options for their digital asset portfolios when banks are prohibited from offering these services, which 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. Assets under custody are not owned by the company, so they are not to be included in the balance sheet as per the accounting convention. Banks must meet capital requirements based on their balance sheets due to the significant impact of sab 121. US banks are required to maintain a dollar of capital for each dollar of assets under custody, as stated in the rule. Bny Mellon would need $48 trillion in capital if this rule were applied to all assets.
This accounting treatment is not recommended by the Basel committee, the international body responsible for establishing bank capital and liquidity rules. 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. Still, there were some risks that needed to be taken into account.
The rule has been strongly opposed by the banks. The former head of State Street Digital, Nadine Chakar, called SAB 121 ‘insane.’ Their schedule was recently restructured by State Street Digital. However, it also laid off some staff shortly after the launch of the ETFs.
The SAB 121 treatment was recognized by Jerome Powell, the Chair of the Federal Reserve, during a congressional hearing.
In November, lawmakers wrote to the Federal Reserve and Office of the Comptroller of the Currency (OCC), urging them to ignore SAB 121.
