UK to Regulate Fiat-Linked Stablecoins
On April 4, 2022, the UK government published its response to its consultation on the UK regulatory approach to cryptoassets, stablecoins, and distributed ledger technology in financial markets (the Consultation Response). This confirms that the government plans to extend regulatory authorization, governance, conduct of business, and reporting requirements under existing regulations to include certain activities relating to fiat-linked stablecoins. According to the government, this is because such stablecoins have the potential to become a widespread means of payment, including by retail customers.
Scope of the Proposals
The new requirements will apply to firms engaged in “activities that issue or facilitate the use of stablecoins used as a means of payment” as well firms that provide or arrange custody of stablecoins.
The proposals are limited to stablecoins that reference a single fiat currency or a basket of fiat currencies. Stablecoins that reference commodities or other cryptocurrencies will therefore generally remain outside the scope of UK regulatory authorization requirements. This is a narrower scope of application than the EU’s proposed Markets in Crypto-Assets Regulation, which includes stablecoins that reference other cryptoassets or commodities as well as other kinds of cryptoassets (see further our update on that Regulation, available here). However, firms that issue, or provide exchange or custodial services relating to such other categories of stablecoins in the UK will still generally be subject to registration and anti-money-laundering requirements (as is currently the case). In addition, the UK government has suggested that it may at a later stage further extend the scope of UK regulation.
The definition of “electronic money” under Electronic Money Regulations 2011 (EMRs) will be extended to include fiat-linked stablecoins. As a result, holders of such stablecoins will be given a statutory right to redeem their coins on demand and at par value — as is currently the case for holders of electronic money (e.g., prepaid card or electronic wallet account holders). However, the proposals recognize that the holder of a stablecoin may not always have a relationship with the issuer. The holder’s relationship may instead be with a third party such as an exchange or wallet provider.
Accordingly, the UK government considers that holders should generally be able to make a claim against either the issuer or the customer-facing entity as appropriate. The legal requirement to allow the redemption of stablecoin on demand and at par value will remain with the issuer, but the issuer may not always be required to fulfill such requests directly. However, the Consultation Response notes that a direct obligation on the issuer may be imposed where the stablecoin carries systemic risks and direct redemption is necessary to address financial stability risks (see further below).
Safeguarding and Capital Requirements
Requirements to safeguard customer funds under the EMRs will apply to funds received in exchange for the issuance of fiat-linked stablecoins. This would mean that, for example, an issuer would need to safeguard £1 for each £1 stablecoin issued. Generally, this means that those funds would need to be segregated and could not be used for any other purpose (e.g., lending) unless they are insured or covered by a comparable guarantee from a nonaffiliated bank.
It is not clear at this stage how (or to whom) the safeguarding requirements will apply where an issuer distributes stablecoins to end customers via an exchange or wallet provider. However, the Consultation Response states that detailed guidance on how the safeguarding requirements will be applied to stablecoins will be issued by the UK Financial Conduct Authority (FCA).
It is also likely that capital requirements under the EMRs will apply to issuers of fiat-linked cryptoassets. Currently nonbank issuers of electronic money are generally required to hold regulatory capital (e.g., share capital) of at least 2% of the average outstanding electronic money in issuance.
The Consultation Response also sets out proposals to regulate firms that provide or arrange for custody of fiat-linked stablecoins. This is intended to capture wallet providers as well as exchanges that offer similar services. The FCA will issue detailed regulatory rules applicable to stablecoin custodians covering (among other things):
- prudential and organisational requirements
- reporting requirements
- conduct of business requirements
- operational resilience
- custody/safeguarding requirements
- consumer protections
Oversight of “Systemic” Stablecoin Payment Systems
Part 5 of the Banking Act 2009 will be extended to apply to “arrangements that facilitate or control the transfer of ‘digital settlement assets,’ ” which would include stablecoins. This will allow the Bank of England to oversee stablecoin-based payment systems where the risks (including the risk of failure) have the potential to be “systemic.” The criteria for being considered “systemic” includes the potential to cause disruption to the UK financial system. Relevant factors include the likely volume and value of transactions, the nature of transactions and links to other systems, as well as substitutability and use by the Bank of England in its role as monetary authority.
The UK government is also proposing to widen the application of the Banking Act to include a defined set of service providers to which regulation could also apply, in particular wallet providers, but potentially also other entities such as exchanges, or custodians of stablecoin reserves. Such entities could be subject to regulation where they make use of “digital settlement assets” and the UK government intends to provide flexibility in the legislation to account for future developments in stablecoins.
The Bank of England will be the lead prudential regulator for systemic stablecoin service providers, including firms providing stablecoin custodial services. The Bank of England has broad powers to publish and enforce codes of practice for operators of payment systems and service providers, set system rules, and issue directions.
The UK government is also considering whether there is a need for a bespoke legal framework for the failure of systemic stablecoin firms. It intends to publish a consultation on this later in 2022.
The UK government intends to extend the application of the Financial Services (Banking Reform) Act 2013 to operators of and participants in stablecoin-based payment systems to ensure that these are subject to appropriate competition regulation and oversight by the Payment Systems Regulator (PSR). The PSR has broad powers over the payment systems it supervises, including powers to give directions, set standards, and amend system rules and agreements relating to the use of payment systems.
Similar to the proposed changes to the Banking Act, the UK government is also considering extending the PSR’s jurisdiction to certain additional entities including wallet providers, exchanges, and custodians of stablecoin reserves.
The UK government intends to introduce legislation implementing the proposals set out in the Consultation Response as soon as parliamentary time allows.
The government has also confirmed that it intends to consult later in 2022 on bringing a wider range of cryptoassets within the regulatory perimeter — that is, beyond the fiat-linked stablecoins discussed in the Consultation Response.