The UK government has issued a response on the stablecoins consultation, conducted with the private sector from the beginning of 2021. The paper summarises views on stablecoins regulation that transpired in the consultation feedback as well as presents the actions the UK government is planning to take with regards to stablecoins regulation.
Stablecoins are recognized as having the potential to rapidly develop into a widespread means of payment, in contrast to other forms of cryptoassets. In order to address the inherent risks this would pose – such as financial system stability and consumer protection – the UK government plans to bring stablecoins into its regulatory perimeter. This will be done mainly by amending existing regulations as opposed to creating new, stablecoins-specific laws.
The original consultation paper also asked the private sector to comment on the need to regulate other cryptoassets (referred to as ‘unregulated tokens’ in the current crypto assets classification in the UK – e.g. Bitcoin, Ethereum etc) and the growth of decentralized finance. These two areas will continue to be observed by the government and the feedback received from the private sector will be reflected in a separate consultation paper. The government considers that additional regulation of a broader set of cryptoasset activities, particularly as a means of investment, should form a second legislative phase.
With regards to the proposed regulatory framework for stablecoins, Coinfirm’s summary will be structured around the following key points:
- Types of assets that will fall under the ‘stablecoin’ definition
- Activities that will be brought into the regulatory perimeter
- Current regulations that will apply
- Regulatory bodies that will oversee stablecoins
Types of Assets That Will Fall Under the ‘Stablecoin’ Definition
The assets IN SCOPE will be stablecoins that reference fiat currencies, including a single currency stablecoin or stablecoin based on a basket of currencies.
The assets OUT OF SCOPE will be algorithmic stablecoins or stablecoins pegged to commodities.
The government plans to develop a definition for ‘payment cryptoasset’ (the exact term of which is to be confirmed later) which will cover “any cryptographically secured digital representation of monetary value which is, among other things stabilized by reference to one or more fiat currencies and/or is issued and used as a means of making payment transactions.“
With regards to the excluded types of stablecoins (algorithmic and commodity-based), the government notes that depending on the particular structure of the arrangements, many tokens which stabilize their value by referencing other assets, like commodities, may already fall within the regulatory perimeter (e.g. as specified investments).
Activities That Will Be Brought Into The Regulatory Perimeter
A broad range of stablecoins related activities will be covered, such as:
- Issuing, creating or destroying tokens
- Value stabilization and reserve management
- Validation of transactions
- Transmission of funds
- Providing custody services for a third party
- Executing transactions in stablecoins
- Exchanging tokens for fiat currency
In practice, the main focus on the new regulatory framework will be stablecoin issuers and wallet providers or exchanges as they conduct most of these activities. More businesses may fall into the regulatory perimeter as included in the list above; however the paper does not clearly outline what activity will trigger what regulatory requirements – this clarity will be provided with the amended regulations.
The paper explains the important role of wallet providers in the stablecoins regulatory framework and provides arguments as to why not only issuers would be covered.
“The role of the wallet provider is a key feature of cryptoassets, unlike traditional e-money. Customer interaction with a stablecoin (i.e. onboarding the customer and providing access to the token) often takes place through the third-party wallet provider (or an exchange), which hold the stablecoin or the means of access to the stablecoin (i.e. the ‘private key’) on behalf of consumers using their services. This allows for stablecoins to be exchanged without redemption of the underlying funds via the issuer. The issuer instead holds the assets or funds backing the stablecoin, whereas the wallet provider or exchange provides access to the token.” (Para 2.66, subsection ‘Introduction of a new regulated custodial activity’ of section ‘The government’s approach to stablecoins’)
“The government considers that regulation is therefore required to ensure the custody or arranging the custody of the token is subject to appropriate regulation.The intention would be to cover the act of someone other than the issuer holding the stablecoin used as a means of payment (or means of access to the stablecoin) on behalf of a third party. It would be intended to capture wallet providers or any firms (e.g. exchanges) offering similar services. It would therefore bring within the UK regulatory perimeter firms that provide services to custody or arrange the custody of stablecoins used as a means of payment on behalf of customers.” (Para 2.67, subsection ‘Introduction of a new regulated custodial activity’ of section ‘The government’s approach to stablecoins’)
Current Regulations That Will Apply
Legal instruments that will require amendment and will apply to stablecoins are:
- The Electronic Money Regulations 2011
- The Payment Services Regulations 2017
- Banking Act 2009
- Financial Services (Banking Reform) Act 2013
Clarification on what set of stablecoins related entities would fall under which act are expected to be provided with the amendments.
The high level list of requirements that would apply under these acts include:
- Authorisation requirements with associated conditions for authorization
- Prudential requirements
- Requirements for the maintenance and management of a reserve of assets
- Orderly failure and insolvency requirements
- Safeguarding the token
- Systems, controls, risk management and governance
- Notification and reporting
- Record keeping; conduct requirements
- Financial crime requirements
- Outsourcing requirements
- Operational resilience
- Service reliability and continuity requirements
- Security requirements
Different requirements may apply to different regulated activities.
The requirement of particular focus is ‘safeguarding’ the token, i.e. the requirement to hold fiat assets backing the coin and ensuring that tokens can be redeemed for fiat money. The requirement will apply mainly to the issuers; however the paper notes that in some cases this requirement will apply to a ‘consumer facing entity’ (e.g. wallet or exchange):
“Within the new regulatory regime proposed for stablecoins, the government considers that it would be unacceptable to be no legal claim at all for the customer, as this would fail to deliver the level of consumer protection necessary and would not provide equivalence between traditional e-money and stablecoin used as a means of payment. However, given the particular characteristics of stablecoins and that the customer relationship may be with a third-party intermediary (such as a wallet), the government considers that customers should generally be able to make a claim to either the stablecoin issuer or, where appropriate, the consumer facing entity.” (Para 2.61, subsection of ‘Changes to the FCA’s e-money and payment services regimes’, section ‘The government’s approach to stablecoins’)
“The government also intends that safeguarding requirements, which exist today under the Electronic Money Regulations 2011, will apply to customer funds received in exchange for issuing a stablecoin. It means in practice that each £1 token issued will need to be safeguarded with £1GBP, and those funds cannot be used for any purpose (e.g. lending).” (Para 2.62, subsection ‘Changes to the FCA’s e-money and payment services regimes’, of section ‘The government’s approach to stablecoins’)
“The legal requirement would continue to sit with the issuer but requiring the issuer to fulfil directly the legal claim requirement is a high bar, which may only be necessary in systemic cases.” (Para 2.61, subsection ‘Changes to the FCA’s e-money and payment services regimes’ of section ‘The government’s approach to stablecoins’)
Regulatory Bodies That Will Oversee Stablecoins
The regulatory mandate will be developed for the following 3 bodies – in line with traditional payment services and e-money where such co-responsibility among the regulators already exists:
- Financial Conduct Authority
- Bank of England
- Payment Systems Regulator
In practice, one company may be regulated by more than one of the above regulatory bodies.
For instance, where a firm providing custody (or arranging custody) also meets the requirements of the Banking Act (therefore is recognised as systemic) the firm would be dual regulated by the FCA and Bank of England.
The Bank of England regulates and supervises systemic payment systems and service providers for those systems. Criteria for recognition as a systemic payment system includes potential disruption to the UK financial system – for example:
- Likely volume and value of transactions
- The nature of transactions and links to other systems
- Substitutability
- Use by the Bank of England in its role as monetary authority
