New document sheds light on dispute over BNY Mellon’s crypto custody activities

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BNY Mellon’s request to the New York Department of Financial Services, recently obtained by American Banker, shows that the bank had no plans to hold capital against crypto assets it holds in custody, although a bulletin later accountant of the Securities and Exchange Commission requires it.

Bloomberg News

WASHINGTON Bank of New York Mellon’s ability to expand its custody business for cryptocurrencies and other digital assets may be hampered by an accounting bulletin issued last year by the Securities and Exchange Commission. It’s a problem BNY Mellon didn’t initially see coming, according to a regulatory filing obtained by American Banker.

BNY Mellon, the nation’s oldest bank, announced its new line of business in October 2022. Earlier that year, the SEC issued Staff Accounting Bulletin 121, which requires custodians of digital assets to register them. on their balance sheets, which raises feasibility questions for banks in particular. those like BNY Mellon who specialize in trust services to grow their digital asset custody business.

For BNY Mellon, this roadblock was only identified after the bank had already begun to establish its digital asset custody business. The bank’s application to the New York State Department of Financial Services to hold digital assets, recently obtained by American Banker, along with the bank’s tax filings, shed light on a stretching timeline from the date the SEC issued its bulletin to around the time BNY Mellon launched its product, highlighting an early conflict between the SEC and BNY Mellon’s understanding of how digital assets would be treated in the bank balance sheets.

BNY Mellon’s challenges could be an indicator that having to hold capital against digital assets is a deal breaker for other banks looking to get into crypto custody. While BNY Mellon is the first systemically important global bank to do so, State Street has tried to break into the business with an outside technology provider, and other big banks, including JPMorgan Chase and Goldman Sachs, have shown interest in cryptocurrency more generally.

BNY Mellon told the New York State Department of Financial Services that digital assets held by the bank as a custodian would not be recorded on its balance sheet, the same way it treats more traditional assets, according to a copy of BNY Mellon’s request, obtained by American Banker via a public records request.

“The Bank intends to support the [Digital Assets Custody] produced in accordance with the same general financial administration considerations, including accounting treatment, liquidity and capital management, regulatory reporting, corporation tax and billing, as for the safekeeping and safekeeping of traditional assets “said the bank in the request.

“The Bank will adhere to US Generally Accepted Accounting Principles (‘GAAP’) and International Financial Reporting Standards (‘IFRS’), which state that digital assets held with a custodian should not be reported on the balance sheet and that only assets associated with fiat currency balances should be reported,” the bank continued.

Although the date of the request is redacted, the footnote citations that indicate the date of access to various online sources are from December 14, 2021. SAB 121 was released a few months later in March 2022.

BNY Mellon declined to comment on the date of the request and how the SEC’s accounting bulletin affects the banks’ future plans for its digital asset custody business.

“We have always complied with the requirements of SAB 121,” a BNY Mellon spokesperson said in a statement.

The SEC declined to comment.

The accounting bulletin appears several times in BNY Mellon’s financial statements after its publication by the SEC. In August, before BNY Mellon announced it would be custodial of crypto assets, the bank said it was “assessing” how the bulletin would apply to the custody of digital assets.

“These guidelines were effective for interim and annual periods ending after June 15, 2022, with retrospective application from the beginning of the fiscal year to which the interim or annual period relates,” BNY Mellon said in its release. second quarter press release, published August 2022. “BNY Mellon currently does not hold any assets that would be affected by the SAB 121 standards. We are currently evaluating the applicability and impact of SAB 121 to our digital asset custody initiatives. .”

In November, the first earnings report after BNY Mellon announced it would hold crypto and other digital assets, the bank changed its tune.

“We adopted the guidance in the third quarter of 2022 and recorded a de minimis asset and liability related to digital assets that we hedge,” the bank said in its third quarter results, released in early November.

In the bank’s annual report, BNY Mellon said that at the end of 2022, it still had an insignificant amount of digital assets in custody.

Because BNY Mellon says it holds such a small amount of digital assets in custody that it is irrelevant to its balance sheet, SAB 121 would not have much impact on the business, experts said.

Chris Odinet, a University of Iowa law professor who studies consumer finance and cryptocurrency regulation, said the small scale of the digital asset custody business at BNY has likely been priced in. early on after the SEC issued its bulletin. Instead, the bank likely sees brand value in offering a broader product line that includes digital assets, he said.

“They’re just saying they’re doing this, we’re offering this to our clients, knowing full well that few of their clients would have the interest and the capital to really trade these things to such a degree that it would really hurt the ability from the bank to making money,” he said. “So it’s like, ‘Look, we’re doing this, we’re at the forefront,’ but knowing that’s lots of smoke and mirrors.”

The SEC’s guidance, however, is likely to be a deterrent to any bank looking to make crypto custody a bigger business, including at BNY Mellon.

“The leverage ratio would have the biggest impact for banks, they would have to hold capital for it,” said Lee Reiners, a lecturer at Duke Law and the Duke Financial Economics Center. “I think this will factor into other banks’ decisions on whether to provide this service.”

As BNY Mellon points out, banks are generally not required to place assets held in custody on their balance sheets in a way that would trigger leverage ratios and capital requirements.

Whether or not crypto assets are basically similar to more traditional assets is at the heart of a larger debate between banks and the SEC. The agency has a proposed new rule for comment, which banks including BNY Mellon strongly oppose, saying the rule would overhaul the custodial bank.

“What people are trying to figure out is how much protecting crypto assets is whether it’s like a bank account or a safe deposit box,” said Bryan Routledge, associate professor of finance at Tepper. School of Business. at Carnegie Mellon University. “The accounting statement says, no, no, if you have the keys, you own the asset the same way as if you took that $10 bill and handed it to the cashier, you no longer own that $10 bill. $10, you now have a liability from the bank where they are going to return that money to you.”

BNY Mellon’s comment letter on the SEC proposal recommends that the SEC withdraw SAB 121, arguing that the SEC proposal both encourages banks to develop secure ways to safeguard digital assets, while in the at the same time the SAB 121 de facto limits their ability to do so.

“On the one hand, the proposal invites custodians to develop “innovative safeguard procedures” for digital assets and paves the way for banks to do so in a way that mitigates the risks on which the SAB 121 is based. “said Roman Regelman, head of BNY. securities and digital services, in their May comment letter. “On the other hand, banks can hardly serve as qualified custodians for digital assets on a sufficient scale if they are still subject to SAB 121 threshold limits by requiring that digital assets in custody be reflected on their balance sheets.”

At some level, crypto assets and traditional assets do not pose the same risks, and there is a reasonable case for treating them differently, said John Sedunov, an associate professor of finance at Villanova University in the School of Business. Specifically, cryptography can present higher technological operational risks.

Unlike, say, a stock certificate that sits in a bank vault, stolen or hacked cryptocurrency could be lost forever, rather than recovered or otherwise returned to its rightful owner. The scale and speed at which this could happen is also much faster compared to most traditional assets that could be held, he said.

“It presents a unique set of risks that you don’t see in other assets,” he said. “So it’s worth taking a closer look at digital assets. Should we be drastic about it? Maybe not.”

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