The Regulation of Stablecoins and the Use of Decentralised Ledger Technology in Financial Markets - A Bitesize Guide to the April 2022 Consultation Response
In January last year, the government issued a consultation paper and call for evidence on the UK’s regulatory approach to cryptoassets and stablecoins. The consultation paper wanted views on how the UK can ensure its regulatory framework is equipped to harness the benefits of new technologies, supporting innovation and competition, while mitigating risks to consumers, market integrity, and financial stability. The government’s proposals in the consultation paper were largely informed by views expressed by UK’s the Cryptoassets Taskforce (made up of HM Treasury, the Bank of England, and the FCA) in its final report setting out a regulatory pathway for the UK to mitigate the risks, and enhance the benefits, of cryptoassets and distributed ledger technology (“DLT”).
Based on 89 responses received from a broad range of organisations, industry trade bodies, universities and individuals, this month the government released its response to the January 2021 consultation paper. The consultation response is broadly split into three chapters which separately consider the government’s approach to stablecoins, investment and wholesale uses of cryptoassets and DLT (which focuses on the adoption and use of DLT in financial market infrastructures), and unregulated tokens and new market developments. The response is reasonably lengthy (not the worst we’ve seen!) and so we have summarised the salient proposals from each chapter.
The Government’s Approach to Stablecoins
Not All Stablecoins Will be Regulated (For Now)
The government recognises that stablecoins have the potential to develop into a widespread means of payment and so the response proposes legislative changes to bring those stablecoins which are used, or intended to be used, as a means of payment within the regulatory perimeter.
Given the potential utility and the potential harm they pose, the government’s focus here really is on stablecoins which are pegged to a fiat currency and used a means of payment. Accordingly, stablecoins which are pegged to other assets, commodities or cryptoassets, or which are algorithmically stabilised, will not, for now, be brought within the regulatory perimeter; however, the government indicates that subject to a longer timetable and while enforcing changes already made to the financial promotions regime and the anti-money laundering/counter-terrorist financing (“AML/CTF|”) regime, it will look at bringing other cryptoassets within the regulatory perimeter. In relation to this, the government states that a further consultation paper will follow.
Proposed Legislative Changes
Given that some issuers and commercial users of stablecoins already are captured by either the Electronic Money Regulations 2011 (“EMRs”) or the Payment Services Regulations 2017 (“PSRs”), we are not surprised to see that the government proposes to expand the EMRs and PSRs as a method of bringing stablecoins used as a means of payment within the regulatory perimeter.
As is currently the case under the EMRs and PSRs, the FCA will be the principal supervisory authority for firms’ conduct, and the proposed legislative changes will provide the FCA with additional authorisation, supervision, and enforcement powers in relation to issuers of stablecoins used as a means of payment. Modifying and using the EMRs and PSRs in this way will mean that stablecoin issuers authorised under either of those pieces of legislation will be subject to the location requirement (i.e., to have its HQ or a branch in the UK) and to the safeguarding requirements so the funds exchanged for stablecoins are segregated from working capital and safeguarded for redemption by customers.
Custodian Wallet Providers
Custodian wallet providers must already register with the FCA as a cryptoassets business and comply with AML/CTF legislation and regulations, but the government also recognises the role which custodian wallet providers play in the acquisition and holding of stablecoins on behalf of customers. Therefore, the government considers it necessary to also ensure that custodian wallet providers are further appropriately regulated. In the consultation response, the government was not as forthcoming with its proposals on how custodian wallet providers will be brought within the regulatory perimeter, instead suggesting that this will be set out in legislation and the FCA will then establish a detailed set of regulatory rules covering prudential and organisational requirements; reporting requirements; conduct of business requirements; operational resilience; custody/safeguarding requirements; and consumer protections.
Systemic Stablecoin Payment Systems
Changes are also proposed to Part 5 of the Banking Act 2009 and the Financial Services (Banking) Reform Act 2013 so that systemic stablecoin payment systems and the service providers of the same are regulated and supervised by the Bank of England and the Payment Services Regulator. Although the threshold for systems being classed as “systemic” is high, it is important to note that stablecoin firms that pass this threshold will be dual regulated by the Bank of England and the FCA, with the Bank of England being the lead prudential regulator. The Bank of England, the FCA, and the Payment Services Regulator will each have to produce regulatory mandates and will have to set out, in an accessible and publicly available format, their approach to co-regulation.
Although not dealt with in detail, the government considers that backstop measures are required to manage the risk of systemic stablecoin payment failures. A further consultation in relation to a bespoke legal framework to support systemic stablecoin payment systems will be released later this year.
Investment and Wholesale Uses of Cryptoassets and DLT
The recent FCA Regulatory Sandbox showed the potential of using DLT systems to deliver tokenised security issuance more expeditiously, cheaply, and efficiently than traditional issuance systems, while also improving transparency of ownership. The government is working with the Bank of England and the FCA to ensure that security tokens continue to fall squarely within the existing legislation and regulations, particularly the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 and the UK Markets in Financial Instruments Directive.
The government recognises the benefit and risk of using DLT as a financial markets infrastructure (“FMI”). Accordingly, it is proposed that HM Treasury, the Bank of England, and the FCA will partner again to develop an FMI Sandbox which is forecast to be up and running in 2023. This FMI Sandbox will create a temporary regulatory framework to allow firms to test and develop DLT and other emerging FMI technologies in a compliant manner. In designing the FMI Sandbox, HM Treasury will need to address the relevant legislation which requires modification or disapplication; the types of entity that will be able to access the FMI Sandbox; the compliance requirements that FMI Sandbox participants will need to meet; the nature and scale of the FMI Sandbox activities; and the roles and responsibilities of the regulators running and supervising the FMI Sandbox.
Central Bank Digital Currencies (“CBDC”)
Although the Bank of England is working with the Bank of International Settlements Innovation Hub, which focuses its endeavours on CBDC and innovative market infrastructures, the government and the Bank of England are still on the fence as to whether to introduce a CBDC into the UK.
Unregulated Tokens and New Market Developments
For now, nothing much is proposed here. The government will work with UK financial regulators to monitor this area and to consider the appropriate future regulation of broader cryptoassets. The government will also work to harmonise guidance and concepts with its international partners. You guessed it; the government will consult later this year to propose an approach.