Today at the SIBOS banking event, an audience member asked about an SEC guidance note (SAB 121) that requires digital asset custodians to add custodial assets to their balance sheet.

For context, regulated custodians will keep any assets, digital or otherwise, completely segregated from their own funds, which is known as remote bankruptcy. Assets in custody are generally not included on a balance sheet because they do not belong to the custodian. In its March letter, the SEC says that any crypto asset with a private key in custody carries such significant risks that it must be included on the balance sheet.

This would close the door on established banks holding cryptocurrencies, and also on the much larger wave of real-world securities and assets expected to be tokenized. This is because the Basel III rules require banks to set aside capital based on their balance sheet. The proposed Basel rules treat cryptocurrencies as the highest risk. The banking and securities associations SIFMA and the ABA have written to the SEC on the custody issue.

State Street and BNY Mellon agree to custody of digital assets

“There are two types of organizations in the market that provide (custody). So you have some of the newer FinTech guys, which are not G-SIBs (global systemically important banks) or banks that are doing that. The impact on them is minimal. They just put it on their balance sheet,” said Nadine Chakar, director of State Street Digital.

Although the rule does not affect FinTechs, the impact on banks is immense. “So for every dollar of crypto that we hold in custody, we have to set aside a dollar of capital on a balance sheet. So I’ll leave it to you to do the math.”

Another panelist, Clearstream, is moving many conventional securities to a digital central securities repository. While Clearstream is based in Germany, it indicates that in the not-too-distant future, a large volume of securities could go digital if other countries provide regulatory clarity as Germany has done.

Together, the three banks represented on the panel hold nearly $100 trillion in conventional assets. BNY Mellon manages $43 billion, State Street $38.2 billion and Northern Trust $13.7 billion.

With those numbers in mind, State Street’s Chakar added: “We’ll all put up a little bit of capital to get going, much like the Bank of New York (BNY) has done. But you can’t climb it. Think about it: $40 trillion in assets. If we put that on our balance sheet, I mean…it’s crazy.”

Caroline Butler, Executive Director of Custody at BNY Mellon, responded: “I agree 100%. I think it’s a real limitation to scale.”

She believes that clients will get superior investor protection from experienced custodians who bring a solution to market. What could be better to protect your assets: a FinTech or a company that protects more than $40 trillion of assets?

BNY Mellon launched its digital asset custody solution this week. Butler added: “We need to have a fair playing field.”

“We need to have the right level of regulation. We need to have the right consistency to protect investors, protect customers. But again, for banks like us to be able to scale our offering, the current limitations will become a real limitation.”

Stephen Prosperi, Director of Business Innovation and Fintech Strategy at DTCC, spoke about the need for regulatory clarity to take projects forward at a more general level. He commented on the SEC letter: “SAB 121 came out of nowhere and really impacted things. So how many more of those will come for the pike? Hopefully, they will be positive, but time will tell.”