FCA proposals on the regulation of stablecoins in the UK

In November 2023, the FCA published its updated proposals on how cryptoassets will be regulated within the UK through Discussion Paper 23/4. With the announcement back in April 2022 that the Government plans to become a ‘global hub for cryptoassets trade and investment’, it is no surprise that they are working on getting the regulatory framework into shape. This latest paper sets out Phase 1 of the series of measures proposed, with stablecoins being the first cryptoasset to be fleshed out under the new regime.

The FCA’s Phase 1 proposals

Facilitated by the Financial Services and Markets Act 2023 (‘FSMA 2023’), amendments will be made to the Regulated Activities Order 2001 (‘RAO’) to bring fiat-backed stablecoins into the regulatory perimeter.

The Government recognises the capabilities of stablecoins being used in day-to-day payments and trading and proposes to regulate stablecoins by including them in the RAO.

The Treasury has outlined that this will relate to stablecoins backed by fiat currencies which can be used as a means of payment, referred to as ‘Approved Stablecoins’. In the Discussion Paper, the FCA outlines that the regulated stablecoin activities will be:

  • issuance of fiat-backed stablecoins in or from the UK; and
  • custody activities carried out from the UK or for UK-based consumers.

As is the case with any regulated activities, issuers and custodians of fiat-backed stablecoins will need to be authorised by the FCA and comply with its handbook rules, conduct of business requirements, and the consumer duty.

Requirements for issuers - backing assets and redemption

The FCA has proposed several requirements to which an issuer of stablecoins must adhere to ensure the FCA’s policies and objectives are met, with the overarching goal of protecting consumers. All stablecoins pegged to fiat currencies must have sufficient backing assets for them to maintain a stable value and function as money like instruments. For this to be achieved, issuers must ensure their stablecoins maintain their value relative to their reference currency(ies) and can be promptly redeemed on demand by the holder. So that this objective can be met, the paper discusses how firms must hold backing assets that are:

  • sufficient to back all the stablecoins they have issued;
  • maintain a stable value; and
  • sufficiently liquid to support the customers right to redeem the stablecoins promptly.

The FCA recognises how firms can gain renumeration through issuance and maintains they will allow issuing firms to retain the interest and returns from the backing assets to generate their revenue. Backing assets will fall within the scope of the Client Assets regime. This will ensure that backing assets are safeguarded and ringfenced from the issuers’ own assets, in situations where a firm fails or there is a significant loss event. The current proposal is for backing assets to be held in a statutory trust and the terms to be held in the FCA’s rules, outlining situations where they may be paid out such as redemption obligations or how they will be distributed if the firm goes insolvent.

Custody, organisational and prudential requirements

As with all things in the financial services space, stablecoin integration will be no different when it comes to the strict requirements imposed on firms to obtain consumer protection and financial certainty in the system. The FCA has disclosed how custodians of Approved Stablecoins will need to ensure segregation of client assets to protect them, maintain good record keeping over ownership, and possibly outline in any agreements their liabilities in cases of loss or failure of the firms, so that consumers are aware of any action they may take.

The Senior Management Arrangements, Systems and Controls ('SYSC') Sourcebook will apply to all issuer and custodian firms, i.e. they must maintain robust governance and carry out effective risk management practices. The scope for financial crime in this area is wide and, recognising this, the FCA proposes a tighter grip on monitoring money laundering. The Bank of England proposes prudential requirements on firms, intending for Approved Stablecoin firms to maintain specified levels of capital and liquidity, so that liabilities can be met and promote faith in consumers. Additional safeguards include the distribution to beneficiaries of the backing assets, in the event a stablecoin firm suffers an insolvency event.

Utilising stablecoins for payment in the UK and overseas stablecoin integration into the UK payment system

Regulating payments: The government recognises that Approved Stablecoins will become a useful means of payment for goods and services in the future and has decided to implement their use into the Payment Services Regulations 2017 (‘PSRs’). To expand the PSRs, the Treasury has outlined two models: a hybrid model whereby the customer uses Approved Stablecoin to purchase goods and a payment service provider performs the conversion to fiat to facilitate the payment; or a pure stablecoin model where both the payer and payee transact in stablecoin and the transaction between them happens ‘on chain’.

Integrating overseas stablecoins via payment arrangers: In line with the Treasury's Policy Statement, there is an ongoing effort to investigate the regulation of overseas stablecoins in UK payment networks. They are considering whether to grant authorities within the PSRs to approve payment arrangers. These authorised entities would then evaluate overseas stablecoins against specified standards. Under this contemplated approach, payment arrangers would fall under PSRs and would need FCA authorisation to assess overseas stablecoins based on criteria outlined by the FCA. Once authorised, payment arrangers determining that an overseas stablecoin complies with and consistently upholds the established standards would permit the use of that stablecoin for transactions within the UK, potentially labelling it as an 'Approved Stablecoin'.

Future phases of regulation on this topic

This FCA’s Discussion Paper seems to be the catalyst for a long series of regulatory proposals for the UK to become a ‘global hub’ for cryptoassets. Already there is discussion of future phases and activities which may be integrated into FSMA 2023, namely dealing in cryptoassets as principal or agent. However, reform or new legislation will be much later.

Feedback is invited on DP23/4 up to 6 February 2024 as the FCA consults to determine the final Policy Statement for Phase 1.

For further information, please contact Louis Hamilton or call 0151 906 1000.