The GENIUS effect: what the U.S. GENIUS Act means for Canadian stablecoin regulation and payments ecosystem

The introduction of the GENIUS Act (Guiding and Establishing National Innovation for U.S. Stablecoin Act) is expected to encourage widespread adoption of stablecoins in traditional finance and payments activities—presenting an opportunity for developers, entrepreneurs and financial service providers in Canada to consider how they will participate in the evolving financial ecosystem.

What you need to know

• The GENIUS Act outlines a regulatory framework for payment stablecoins within the U.S., providing clear rules for issuers in a bid to de-risk USD fiat-backed payment stablecoins.
• To facilitate international transactions and interoperability with USD denominated payment stablecoins issued overseas, the U.S. Treasury Department plans to implement reciprocal arrangements with jurisdictions that have “substantially similar” regimes.
• The Act characterizes payment stablecoins as payments instruments that are not securities or commodities. In contrast, the Canadian stablecoin framework classifies payment stablecoins as securities and/or derivatives, thereby requiring compliance with Canadian securities laws.
• The GENIUS Act may be the catalyst that spurs Canadian regulators to reconsider their approach to payment stablecoins, better harmonizing it with that of the U.S. and other jurisdictions.

Implications of the GENIUS Act on Canadian stablecoin regulation and payments ecosystem

With the passing into law of the GENIUS Act, the U.S. has moved forward with the implementation of its regulatory framework governing the issuance and distribution of payment stablecoins (referred to as “value-referenced crypto assets” in Canadian securities law discourse).

We consider the impact of the GENIUS Act on the Canadian stablecoin regulatory environment and the implications of stablecoins on Canadian financial service providers.

Overview of the GENIUS Act

The GENIUS Act is a regulatory framework that governs the issuance of payment stablecoins within the U.S. Of note, the Act characterizes payment stablecoins as payment instruments and not securities, whereas the Canadian regulatory framework characterizes payment stablecoins as securities and/or derivatives.

The Act outlines certain elements and provisions:

• Not securities: payment stablecoins are defined as a digital asset designed for use as a means of payment. They are not securities or commodities and permitted issuers are not investment companies under U.S. securities laws.
• 1:1 reserve requirement and reporting: permitted issuers must maintain reserves comprising of cash, short-term U.S. treasuries and other approved high-quality liquid assets backing the outstanding payment stablecoins on at least a 1:1 basis. Permitted issuers must publish monthly reserve composition reports that have been examined by a registered public accountant.
• Licensing and oversight: only subsidiaries of an insured depositary institution, an entity approved by the Office of the Comptroller of the Currency, or an entity approved by a state payment stablecoin regulator may issue payment stablecoins. These entities will be under the supervision of federal and/or state regulators depending on the issuer’s license and size.
• Customer protection: the legislation requires protections for payment stablecoin holders upon the insolvency of a permitted issuer and requires issuers to maintain public redemption policies. Custodians of payment stablecoins and payment stablecoin reserves must be regulated and the funds of the issuers and holders must be segregated from, and not comingled with, the assets of the custodian.
• Reciprocity provision: to facilitate international transactions and interoperability with USD denominated payment stablecoins issued overseas, the U.S. Treasury Department plans to implement reciprocal arrangements with jurisdictions that have “substantially similar” payment stablecoin regulatory regimes.

The regulation of stablecoins in Canada

The Canadian approach to the regulation of stablecoins is outlined in CSA Staff Notice 21-333 Crypto Asset Trading Platforms: Terms and Conditions for Trading Value-Referenced Crypto Assets with Clients, which describes the terms and conditions that issuers of stablecoins must comply with. While the U.S. and Canadian approaches differ in their characterization of payment stablecoins, the Staff Notice does contain comparable provisions to the GENIUS Act—such as reserve requirements (1:1 reserve ratio consisting of cash and high-quality, short-term liquid assets), reporting requirements (monthly and annual), and robust consumer protection measures requiring reserve assets to be held by qualified custodians in a manner where only stablecoin holders, not other creditors, can access the stablecoin reserve assets in the event of an issuer insolvency. The CSA’s approach to characterizing stablecoins as securities and/or derivatives also differs from the approach taken by the EU (which characterizes stablecoins as E-Money Tokens, not securities, under the European Markets in Crypto-Asset Regulation (MiCA)), and other jurisdictions.

Considerations for Canadian financial service providers

The implementation of the GENIUS Act, and the governmental oversight and supervision of payment stablecoin issuers it brings, is expected to lead to greater mainstream adoption of payment stablecoins within the U.S. and encourage greater engagement by financial institutions with these instruments. Furthermore, the recent announcement by Société Générale to issue a USD stablecoin¹, combined with JP Morgan’s use of the JPM Coin on its blockchain platform², and PayPal’s use of its USD stablecoin (the PYUSD)³, has led to Canadian financial service providers examining how they will participate in the emerging stablecoin payments landscape.

Considerations for financial service providers include what services to provide to payment stablecoin issuers, how to service merchants that accept payment stablecoins, whether to deploy payment stablecoins in their internal and client-facing operations and how to otherwise participate in the transfer, settlement, redemption and custody of payment stablecoins. These considerations will require service providers to develop and deploy technical capabilities and third-party partnerships to develop the infrastructure needed to operationally support these instruments.

In addition to the technical and operational requirements, service providers also need to be aware of the regulatory and compliance requirements associated with digital asset activities.

Regulatory requirements: how to play the waiting game

Although certain Canadian regulatory authorities, such as the anti-money laundering regulator (FINTRAC), have provided guidance to entities dealing in virtual currencies, there is a lack of guidance from other Canadian regulators regarding the engagement with payment stablecoins by their members. The Canadian Retail Payments Activities Act (RPAA) currently excludes digital assets from its scope (although they can be brought under the RPAA by regulation if needed) and, although the Office of the Superintendent of Financial Institutions Canada (OSFI) has released certain guidance relating to the capital and liquidity treatment of crypto-asset exposures for financial institutions, OSFI has not provided more general guidance on the extent to which financial institutions may support the transfer, storage, redemption and processing of stablecoins.

In advance of regulatory developments, some Canadian financial service providers have begun to assess how they can participate in the payment stablecoins ecosystem. This includes examining implications of stablecoins on their business operations, identifying gaps in operational, regulatory and compliance capabilities, and beginning consultations with regulatory authorities.

Looking ahead: regulatory convergence or divergence?

With major financial systems, such as those of the U.S. and EU, characterizing stablecoins as payment instruments, domestic industry participants are calling for a similar classification in Canada in a bid to make use of any applicable reciprocity provisions and maintain interoperability. The GENIUS Act may be the catalyst that spurs Canadian regulators to reconsider their approach.