New York Sets Guidance for Approval of Virtual Currency Activities

All New York banking organizations—and all New York licensed branches and agencies of foreign banking organizations (“Covered Institutions”)—must get approval from the New York State Department of Financial Services (“NYDFS”) prior to engaging in virtual currency-related activity. The NYDFS clarified its expectations on that requirement in the form of an industry guidance letter dated December 15, 2022. A few weeks earlier, NYDFS proposed a rule on costs related to supervision and examinations and how they will be assessed on virtual currency businesses. Here are the highlights.

Virtual Currency Activity

In its guidance, NYDFS reaffirms the definition of virtual currency contained in the 2015 statutory definition and explains its regulatory interest in protecting state residents. In short, entities that engage in “the direct or indirect offering or performance of any other product, service, or activity involving virtual currency that may raise safety and soundness concerns for the Covered Institution or that may expose New York customers of the Covered Institution or other users of the product or service to risk of harm” must get approval from the regulator.

By “virtual currency business activity,” the NYDFS is referring to conduct involving (i) receiving or transmitting virtual currency (with certain exceptions, i.e. for non-financial purposes or a nominal amount); (ii) holding or custodying virtual currency on someone’s behalf; (iii) buying and selling virtual currency; and/or (iv) providing virtual currency exchange services. NYDFS offers examples of activities that fall within this definition. They include a broad range of activity such as providing digital wallet services, lending activities backed by virtual currency assets, helping customers to participate on a virtual currency exchange, holding virtual currencies on a customer’s behalf, any stablecoin services, and traditional banking services that may utilize public blockchain technology.  

The guidance applies to covered institutions wanting to initiate virtual currency activity as well as to institutions wanting to add any new or significantly different virtual currency-related activity, even an activity that may involve a third party. (NYDFS recommends that institutions who want to add to their existing virtual currency activity notify their NYDFS point of contact to “enable the Department to review and seek additional information or clarification, and impose any supervisory requirements, if needed.”)

Submissions: Required Information

Covered institutions must provide a written submission of proposed activity that would allow the regulator to make a “comprehensive assessment” that the activity would be “appropriate for a covered institution to undertake.” The submission must be provided to NYDFS 90 days prior to engaging in the activity.

NYDFS laid out the types of information it expects in any submission. These include:

1. A comprehensive business plan – NYDFS lists eight elements: (i) the legal entities that will be used; (ii) information on the operating model and technology; (iii) information about the use of any third-party service providers; (iv) costs and revenue targets; (v) the target customer base and fees; (vi) information on the expected impact on users; (vii) a formal project plan (e.g. budgets, schedules, staffing, etc.); and (viii) a comprehensive risk assessment and monitoring framework (see below).
2. A risk management framework – NYDFS wants institutions to submit information “to identify, measure, monitor, and control all risks arising from the activity (e.g., risks as to operations, credit, market, capital liquidity, cyber security, technology, third party provider, strategic, legal and reputation).
3. A governance framework – NYDFS wants to see all materials related to internal board/management approvals of the proposed virtual currency activity; all the designations for oversight; explanations on how the risks would be integrated into the institution’s overall governance framework; and all related controls and compliance processes.
4. A customer protection approach – NYDFS wants to see policies and procedures, sample agreements with users (whether by the institution or a third-party provider), disclosures, and a representative sample of marketing materials.
5. A financial analysis – NYDFS wants submissions to include an explanation describing any anticipated impact the new virtual currency activity may have on the entity’s capital and liquidity position.
6. A legal and regulatory analysis – NYDFS wants to see the legal analysis underlying the internal approval process for the activity, including the reasoning that would permit the activity and attendant legal risks.

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Paying for it All

On December 1, 2022, NYDFS announced a proposed regulation establishing how supervisory and examination costs will be assessed on virtual currency businesses. If approved, virtual currency institutions will be billed five times per year: quarterly and with an adjusted bill at end of the fiscal year. Licensed firms would have to pay within 30 days; dually-registered institutions under both state banking regulations and cryptocurrency regulations will be billed separately. Superintendent of Financial Services Adrienne A. Harris commented, “the ability to collect supervisory costs will help the Department continue protecting consumers and ensuring the safety and soundness of this industry.”  

Conclusion

While there is considerable overlap across the categories of information that NYDFS wants institutions to submit, doing so may not be a simple task, and approval is not assured. As applied to virtual currency businesses, NYDFS approvals and licensure have far-reaching impact. As designed, this state process is sure to be the subject of broader debate over the future of virtual currencies. Meanwhile, the proposed rules on assessments and costs related to supervision and examinations are more than mere housekeeping; they indicate that the state agency is gearing up to take a hard look on virtual currency activity in 2023 and beyond. Bates will keep you apprised.

Bates Group’s MSB, FinTech, and Virtual Assets practice offers guidance and services for Money Services Businesses and financial institutions, fintech and cryptocurrency firms. Our subject matter experts work directly with firms and counsel to design and implement policies and programs and to ensure they are AML-compliant. Our MSB and AML Teams help obtain and maintain Money Transmitter Licenses nationwide, also engaging with clients for BSA/AML/OFAC Program Development, Risk Management, Training, Advisory Services, and Independent Reviews.

 

Contact Bates today to learn how we can support your Virtual Currency compliance and state licensing acquisition and maintenance needs.