If you love investing in businesses that are on the bleeding edge of biotechnology, psychedelics companies are right up your alley. Despite substantial cultural baggage and significant legal hurdles, psychedelic medicines are proving themselves to be highly effective at treating mental illnesses like depression and post-traumatic stress disorder (PTSD), and that means they're likely to be quite lucrative for the developers.

Legal obstacles still abound, and some might be on the verge of getting worse -- but others seem to be starting to clear. Two important potential regulatory changes are bouncing around the U.S. government this week; let's see what they might mean for psychedelic stocks.

Regulators might throw cold water on a few promising molecules

On July 13, the Drug Enforcement Agency (DEA) said it was scheduling a public hearing for Aug. 22, so people would have a chance to comment on a proposed rule that would move five psychedelic compounds into the Schedule 1 category. The substances that would fall under Schedule 1 restrictions are DiPT, 4-OH-DiPT, 5-MeO-MiPT, 5-MeO-DET, and 5-MeO-AMT, none of which are currently assigned an official schedule classification, and none of which have been popular subjects of drug development work in the psychedelics industry so far. 

Leading companies like Atai Life Sciences (ATAI -3.14%) and Compass Pathways (COMP -0.61%) aren't currently investigating any of the molecules that would fall under the new scheduling, but if the regulations are put into practice, they would still be forced to constrain future development efforts to avoid accidentally violating the law. Especially for a company like Atai with a large and highly diversified psychedelics pipeline, such a constraint could ultimately be quite burdensome. But for biotechs more focused on developing medicines from a few core psychedelic molecules, like Compass, having a few potential paths closed by regulators won't be as significant in the long run.

Either way, the financial impact to shareholders will be minimal for now, but it could easily limit the size of the market for psychedelic medicines by precluding potentially valuable approaches. If the DEA's Office of Administrative Law Judges finds the public's comments to be persuasive, it could suggest less-restrictive scheduling. That'd be a boon for the psychedelics industry in the long run, but it might not make much of a dent right away. Agency regulators responsible for scheduling aren't obligated to abide by what the office recommends.

Still, that the DEA is interested in hearing from the public at all is significant, and it points to shifting norms surrounding the medicalized use of psychedelics. And those shifts are yielding other proposed regulations that might have even greater effects.

Action in Congress could be big

Also on July 13, legislators in the House of Representatives voted in favor of a handful of drug policy amendments that are now bundled into the National Defense Authorization Act (NDAA). The amendments would include a bevy of policies, such as requiring the Department of Defense (DOD) to investigate psychedelics like MDMA and psilocybin as treatments for PTSD and chronic pain and enabling DOD leaders to issue grants for such research.

Considering that Compass' COMP360 therapy is based on psilocybin, and is being investigated in a mid-stage clinical trial for its efficacy in treating PTSD and that Atai is investigating MDMA's utility for the same purpose in preclinical work, the new policies could potentially catalyze an immediate jump in their share prices if they become law. It's also possible that the pair could get funded by the government directly to advance their programs, which would be a big boon because it'd let them stretch their cash reserves significantly further. Still, these two companies aren't the only ones studying those molecules for such indications, so they likely wouldn't be the sole beneficiaries of new government investment in psychedelics.

While there's no guarantee the policy package will make it into the final version of the NDAA or ever become law, the positive impact on the industry could be massive. The DOD is a research powerhouse, with its 2022 budget request calling for spending of around $112 billion. Even if only a very tiny slice of that pie ends up being distributed to psychedelics research, it would likely catalyze significant growth, because the government would need partners in the private sector to help implement its investigations and projects. And an increase in government-funded research would provide yet another piece of social support for the idea that psychedelic therapies are a legitimate avenue for discovery and development.

Finally, investors should be aware that the new policies being attached to the NDAA are unlikely to be the last, whether or not they pass. The psychedelic industry is still in its infancy, and significant regulatory work remains to be done on establishing standards for drug quality, drug safety, and even competition. Make no mistake: These newly proposed policies are extremely promising for psychedelic stocks, and if passed, they'll be a significant tailwind for quite some time.