With the Democratic majority in Congress in serious jeopardy as Americans prepare to head to the polls in November 2022, Democratic control of the executive branch and regulatory apparatus will remain intact post-election. As we look forward to 2023, we expect that gridlock is likely to be the order of the day.
Based on current public opinion surveys, should current economic and geopolitical conditions persist, Republicans are the odds-on favorite to recapture at least one (if not both) Houses of Congress in this Fall’s US elections. Such a result would be in line with past trends, in which midterm losses have been suffered by the incumbent party.
Among other things, assuming divided government is in the cards of 2023, gridlock is likely to be the order of the day throughout the 2024 Presidential election cycle. On the one hand, new GOP congressional leaders are expected to strongly promote fiscal spending discipline, a new debate on energy policy to address inflation and energy security, and to emphasize greater oversight over the Biden administration’s policies and activities. Meanwhile, the Biden Administration is expected to utilize the levers of executive and regulatory power post-election to effect their policy priorities.
Even if the control of the Congress flips into Republican hands, expect the Biden Administration and the regulatory agencies to continue to push toward climate and ESG accountability, including policies to promote climate stress testing and enhanced public disclosure of climate activities.
Observers are also keenly watching the use of administrative agency power, as well as the potential limits of that authority, should Congress turn red in November. A good litmus test may be the 5th Circuit Court’s recent decision on the Securities and Exchange Commission’s use of administrative procedures to rule on alleged securities-fraud activity. If allowed to stand, the ruling has the potential to affect many standing financial-regulatory administrative actions and rulings using delegated authorities. Given the uncertainty caused by the ruling, there is potential for the Supreme Court to consider this matter, which if it concurs may further limit the authority of administrative agencies.
Meanwhile, fintech regulation remains top of mind for policymakers. Fintech companies are using technology solutions to provide services (e.g. such as payments and lending products) to markets typically served by banks traditional banks. Additionally, Fintechs benefit from lower costs because they are neither prudentially regulated or examined like their bank counterparts nor do they have to maintain the same level of reserves, capital or liquidity. Congress and the regulators are actively considering the benefits of this enhanced competition versus the potential safety and soundness risks, the consumer protection risks that may be present, and level playing field competiveness aspects that may be present.
The regulatory treatment of digital assets has also captivated the attention of DC policymakers, as they ponder the longer-term issues related to the implications for financial crime, consumer and investor protection, and the ultimate ‘use case’ for crypto assets and their underlying technologies. Meanwhile, market participants are looking for regulatory guidance (i.e. the rules of the road) on how these assets will be defined (e.g. as a commodity, security or banking product) and then which agency will regulate those products. In line with the Biden administration’s “Ensuring Responsible Development of Digital Assets” executive order issued earlier this year, the CFTC, SEC and other regulatory bodies are poised to increase their interest in digital assets, including regulation of crypto exchanges, as these agencies make the case for regulating these new instruments.
Meanwhile, a recent Staff Accounting Bulletin from the SEC (SAB 121), which asserted that any entity holding cryptocurrency under a custody arrangement must hold such assets on their balance sheet. This is a departure from the prevailing standard as a banking entity does not currently does not include assets under custody on its balance sheet unless the entity also has control over those assets. This poses a particular problem for banks, as banks would have to hold capital against these instruments, if they were to hold them on behalf of clients. Further, it is inconsistent with GAAP because if an asset appears on one company’s balance sheet for GAAP purposes, it cannot be an asset on another entity’s simultaneously. On the face of it, the new guidance would seem to deter banks from taking custody of digital assets, so long as the SEC perceives elevated risk in allowing multiple owners to access the same crypto pool.
As has often been the case with tech issues, Congress is beginning to wrap its head around the concepts present in the use and regulation of digital assets, thereby putting any substantive legislation potentially on the agenda for 2023. This makes the SEC’s un-appealable decision on SAB 121 all the more impactful to the banking community, say observers, as it is likely to have a pronounced effect on the obligations of all custody bank providers that may have an interest in digital assets.