Responsible Financial Innovation Act: A Proposed Digital Asset Regulation With Implications for Products and Regulatory Frameworks

On June 7, 2022, Sens. Cynthia Lummis, R-Wyo., and Kirsten Gillibrand, DN.Y., introduced the Responsible Financial Innovation Act (RFIA), the first comprehensive legislative proposal to create a regulatory framework for digital assets in the United States. Specifically, the RFIA consists of 70 pages of proposed legislation that touches on tax, securities, commodities, consumer protection, payments, and banking laws and provides guidance on how federal agencies should interact with one another when considering digital assets. Further, the RFIA provides rules that allow for the issuance of payment stablecoins.

Sens. Lummis and Gillibrand say the purpose of the legislation is to “encourage[ ] responsible financial innovation, flexibility, transparency and robust consumer protections while integrating digital assets into existing law.” Many analysts believe that this legislation will set the tone for how Congress writes the rules for digital assets in the coming years. It will likely be significantly amended before ever becoming law, and the prospects for any digital asset-related legislation becoming law during this Congress are remote. Although portions of the RFIA may provide a roadmap for regulators such as the Securities and Exchange Commission (SEC) and Commodity Futures Trading Commission (CFTC) to consider implementing in the near term.

Here is a list summarizing certain significant provisions from the RFIA.

  1. Notable definitions: The RFIA addresses the lack of standard definitions applicable to the industry and proposes to introduce the following terms and concepts:
    • “digital asset”: a natively electronic asset that (i) confers economic, proprietary, or access rights or powers and (ii) is recorded using cryptographically secured distributed ledger technology or any similar analogue; and includes virtual currencies, ancillary assets, payment stablecoins and other securities and commodities
    • “digital asset intermediary”: a person who holds a license, registration, or other similar authorization who may conduct market activities relating to digital assets; this includes a licensed, registered, or otherwise authorized person who issues a payment stablecoin but does not include a depository institution
    • “Distributed ledger technology”: technology that enables the operation and use of a ledger that (i) is shared across a set of distributed nodes that participate in a network and store a complete or partial replica of the ledger, (ii) is synchronized between the nodes, (iii) has data appended to the ledger by following the specific consensus mechanism of the ledger, (iv) may be accessible to anyone or restricted to a subset of participants, and (v) may require participants to have authorization to perform certain actions or require no authorization
    • “payment stablecoin”: a digital asset that is (i) redeemable, on demand, on a one-to-one basis for instruments denominated in a legal tender of any jurisdiction, (ii) issued by a business entity, (iii) accompanied by a statement from the issuer that the asset is redeemable as specified in (i), (iv) backed by one or more financial assets, and (v) intended to be used as a medium of exchange
    • “smart contract”: (i) computer code deployed to a distributed ledger technology network that executes an instruction based on the occurrence or nonoccurrence of specified conditions or (ii) any similar analogue. This may include taking possession or control of a digital asset and transferring the asset or issuing executable instructions for these actions
    • “Virtual currency”: (i) a digital asset that (a) is used primarily as a medium of exchange, unit of account, store of value, or any combination of such functions, (b) is not legal tender, and (c ) does not derive value from or is backed by an underlying financial asset (except other digital assets); and (ii) includes a digital asset that is accompanied by a statement from the issuer that a denominated value will be maintained and be available upon redemption, based solely on a smart contract
  2. Tax Laws: In relation to tax laws, the RFIA
    • defines “broker” in the Internal Revenue Code of 1986 as any person who (for consideration) stands ready in the ordinary course to effect sales of digital assets at the direction of their customers
      • Brokers must report securities transactions effected to third-party accounts that are not maintained by a broker each calendar year.
    • permits non-US persons who use a US financial institution to conduct digital asset trading to use current safe harbors for securities and commodities trading activity under certain conditions
    • establishes that certain decentralized autonomous organizations are business entities
      • To be recognized under the RFIA, a decentralized autonomous organization must be properly incorporated or organized under the laws of a jurisdiction as a decentralized autonomous organization.
    • clarifies that transactions pursuant to digital asset lending agreements are not generally taxable events
    • requires the Internal Revenue Service to adopt guidance on certain issues in the digital asset industry
    • requires the Government Accountability Office to conduct an analysis related to retirement investing in digital assets
    • establishes that digital assets received through mining or staking activities are not gross income until the disposition of those digital assets
  3. Securities Laws: With respect to securities laws, the RFIA
    • introduces the concept of “ancillary assets,” which are intangible, fungible assets provided through an “investment contract” under the Securities Exchange Act (ie, a security under the test), subject to certain exclusions
    • establishes a reporting structure for ancillary assets and states that ancillary assets whose issuers comply with such reporting structure shall be presumed to be commodities and not securities
    • requires the SEC to issue guidance relating to “good control location” under the Customer Protection Rule for digital assets that are securities and guidance to enable a broker-dealer to perform both trading and custody services within the same entity for such assets
    • requires the SEC to complete its ongoing modernization of the Custody/Qualified Custodian and Customer Protection Rules
  4. Commodity Laws: With respect to commodities laws, the RFIA
    • establishes that the CFTC has exclusive spot market jurisdiction over all fungible digital assets that do not confer debt or equity interest, a profit share, or similar right in a business entity
      • The RFIA explicitly carves out from the CFTC’s jurisdiction “digital collectibles and other unique digital assets.”
    • establishes restrictions on how a futures commission merchant may use a digital asset customer’s digital assets
    • provides a framework for digital asset exchanges to register with the CFTC
    • clarifies certain points regarding the treatment of digital assets in bankruptcy
    • provides that a payment stablecoin is neither a commodity or security
    • establishes digital asset exchanges as “financial institutions” under the Bank Secrecy Act
    • permits the CFTC to impose a small user fee on digital asset exchanges
  5. Consumer Protection Laws: With respect to consumer protection, the RFIA
    • imposes on providers of digital assets certain disclosure requirements and other standards related to customer agreements, including information regarding a digital asset’s source code and legal treatment under commodities and securities laws
    • requires digital asset service providers and customers to agree on terms of settlement finality for all transactions
    • establishes the right to keep digital assets personally owned
  6. Payment Laws: With respect to laws governing payments, the RFIA
    • provides that depository institutions may conduct all incidental activities relating to payment stablecoins, including issuance
    • requires issuers of payment stablecoins to
      • maintain 100% backing of any issued stablecoins in high-quality liquid assets
      • provide public disclosures that describe the assets backing the payment stablecoin
      • have the ability to redeem all outstanding payment stablecoins at par
    • requires the Secretary of the Treasury to adopt final guidance clarifying the sanctions compliance responsibilities and liabilities of payment stablecoin issuers with respect to downstream transactions
    • provides that a National Bank Association may be chartered for the purpose of issuing a payment stablecoin
    • establishes tailored holding company supervision for depository institutions exclusively engaged in issuing payment stablecoins
    • establishes an “Innovation Laboratory” within the Financial Crimes Enforcement Network to study changes in financial technology and make recommendations to Congress and conduct pilot projects with financial companies to more effectively facilitate the supervision of financial technology
  7. Banking Laws: With respect to banking laws, the RFIA
    • requires the Federal Reserve Board of Governors to study how distributed ledger technology may reduce risk for depository institutions
    • requires Federal Reserve banks to make available a segregated balance account to a depository institution upon request
    • directs the Federal Reserve Board of Governors to assume responsibility for issuing routing transit numbers to depository institutions
    • clarifies that the existing one-year review-period requirement under existing law (12 USC 4807) applies to the Federal Reserve banks
    • requires the Federal Financial Institutions Examination Council to publish final guidance related to digital asset activities of depository institutions
    • codifies common principles relating to depository institution asset custody
    • prevents a federal banking agency from restricting or discouraging a depository institution from entering into or maintaining a banking relationship with a specific customer based on reputation risk
    • requires that federal banking agencies provide appropriate reasons for terminating a customer account
  8. Federal Agency Guidance: With respect to interagency coordination, the RFIA:
    • requires each federal financial regulator to provide individualized interpretive guidance with respect to matters under its jurisdiction to licensed or regulated persons within six months of a request
    • permits existing state financial technology sandbox operators to operate on an interstate basis after receiving approval from state and federal regulators
    • requires state bank supervisors and the Money Transmission Regulators Association to ensure substantially uniform treatment of digital assets under money transmission laws
    • establishes rules for the confidentiality of information shared between state and federal financial regulators
    • requires that the Secretary of the Treasury study decentralized finance
    • requires that the Federal Energy Regulatory Commission conduct a study analyzing energy consumption in the digital asset industry
    • requires the CFTC and SEC to develop a proposal for the establishment of registered digital asset associations
    • requires the CFTC and SEC to develop guidance related to cybersecurity for digital asset intermediaries
    • establishes the Advisory Committee on Financial Innovation to study and report on digital assets; consumer education and financial literacy; market structure in the securities and commodities markets; banking, payments, and settlement; consumer credit; financial inclusion; financial system efficiency; systemic risk reduction; financial services competition; and the state-federal partnership in financial services regulation

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