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Federal charter for Paxos edges fintech into banking system

Critics worry fintech is sidestepping regulations

Jo Ann Barefoot, CEO of the Alliance for Innovative Regulation, says the OCC decision on Paxos shows that regulators are recognizing the risk of falling behind changing technology.
Jo Ann Barefoot, CEO of the Alliance for Innovative Regulation, says the OCC decision on Paxos shows that regulators are recognizing the risk of falling behind changing technology. (Tom Williams/CQ Roll Call file photo)

A federal bank regulator further integrated financial technology into the traditional banking system when it granted a national trust bank charter to a crypto company, according to people tracking the rise of digital assets.

The Office of the Comptroller of the Currency last month granted a preliminary conditional charter to Paxos National Trust, a bank that will take over the digital asset services of New York’s Paxos Trust Co. LLC, and offer them nationwide.

Paxos is a digital asset custodian, meaning it can hold bitcoin or other such currencies for clients such as PayPal and Credit Suisse, using a patchwork of state licensing approvals. Its national charter means it is now the first such company to be regulated at both the state and federal levels, which increases its ability to roll out services.

Jo Ann Barefoot, a former deputy comptroller of the currency and former staff member for the Senate Banking Committee, said the action marks a notable acceleration that reflects a continuing trend of fintechs wanting to get national charters in order to avoid undertaking the expense, time consumption and complexity of state-by-state licensing.

Barefoot is co-founder and CEO of the Washington, D.C.-based policy group Alliance for Innovative Regulation.

Fintechs such as Paxos have long complained that a lack of a national licensing system has required them to navigate a regulatory maze to conduct business nationwide. It says it sees significant benefits in being regulated nationally and by states.

Dan Burstein, general counsel and chief compliance officer for Paxos, told CQ Roll Call that the federal charter will streamline the company’s ability to adopt a nationwide business plan, such as offering new products and services. In addition, there are reputational benefits from customers and potential financial institution partners seeing Paxos thoroughly vetted by state and federal authorities, Burstein said.

Paxos has been regulated by the New York State Department of Financial Services since May 2015. After receiving its conditional national trust license, Paxos said it’s keeping its New York approvals. 

The OCC said Paxos National Trust will be an uninsured national bank with operations limited to those of a trust company. It will provide a range of digital asset services that are permissible for a national bank, including custody of digital assets; custody and management of stablecoin reserves pegged to U.S. dollars; and trading services and enabling users to buy and sell cryptocurrency, the comptroller’s office said.

Stablecoins are digital assets whose value is pegged to another currency or basket of currencies.

Norman H. Roos, senior counsel at the Robinson & Cole law firm, told CQ Roll Call the approval marks the beginning of a new regulatory approach. 

“Paxos holds itself out as a regulated blockchain infrastructure platform that, among other things, holds and safeguards digital assets as a regulated trust,” Roos said. “As a digital asset custodian provider of a dollar-pegged stablecoin, Paxos is definitely a new and different type of ‘financial institution.’”

Barefoot said OCC’s decision shows that regulators are accelerating in response to market innovation and recognizing the risk in falling behind changing technology.

“The agencies need to keep pace, and that requires some regulatory innovation,” she said.

Resistance from traditional banks

Not everyone is on board. The Bank Policy Institute, a research group that has an interest in protecting the traditional system, has complained that fintech companies are skirting the rules.

“A lot of fintechs are trying to act like banks while avoiding the supervisory and regulatory framework that applies to actual banks,” BPI said May 12 in a post on its site. “For these fintechs, the duties and responsibilities — and costs — that come along with a real bank license are simply too great.”

It said fintechs have been lobbying federal and state banking authorities to give them “novel” bank charters while subjecting them to just a fraction of the regulatory and supervisory obligation of an ordinary bank.

“Their lobbying efforts have paid off, and a number of these novel charters are now available,” the organization said.

The OCC, which supervises the national bank system, has taken a lot less heat with the Paxos decision than with an earlier decision to approve special purpose bank charters for fintechs.

State regulators accused the federal government of usurping their authority to oversee nonbank financial firms operating in their local jurisdictions. New York and others filed suits that are still pending, complaining that the OCC overstepped its federal and congressional authority and was stomping on the rights of states to supervise financial institutions operating within their boundaries.

The OCC, part of the Treasury Department, supervises about 1,145 national banks, federal savings associations, and federal branches and agencies of foreign banks that have about $14.5 trillion in assets — about two-thirds of all U.S. commercial banking assets.

Attorney Sanford M. Brown, a partner in the Dallas office of Alston & Bird LLP, said the Paxos decision “should not be nearly as controversial” as other proposed fintech charters that have given rise to litigation. Trust companies can’t take deposits and, therefore, don’t have deposit insurance. They also typically don’t make loans, offering fiduciary services for a fee instead. Other fintechs are hoping to move into these areas, and that is causing ruffles.

Brown said Paxos’ charter will make things simpler for it down the road.

“If Paxos decides that the execution of its business plan (either the current one or a revised one) is being impeded by having to deal with the trust company/fiduciary laws of multiple states, it is likely to conclude that the national charter is much more efficient,” he told CQ Roll Call. “One set of rules, one regulator, no state-level licensing or supervision. … To me, it is a smart strategy.”

He said New York for several years has offered a trust company charter for cryptocurrency businesses, “but even New York cannot offer a charter that allows the business to be conducted across state lines seamlessly.”

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