The new regulatory regime for stablecoins

As announced at FinTech Week, the Treasury has confirmed its intention to take the necessary legislative steps to bring activities that issue or facilitate the use of stablecoins used as a means of payment into the UK regulatory perimeter. The policy approach taken by the Treasury remains largely consistent with the proposals set out in its January 2021 consultation - our briefing on the Treasury's consultation can be read here. This alert highlights the updates and changes announced by the Treasury, and should be read together with our earlier briefing for a fuller picture of the forthcoming regulatory regime.

Tokens within scope

In response to feedback received, the Treasury has further refined the scope of the regime. Unfortunately, there is still no confirmed definition of stablecoin - future legislation will provide clarity on the scope of activities to which the regime will apply, and the regulators will supplement that legislation with more detail on the activities and tokens in scope. However, the Treasury is minded to develop a definition for, e.g., a "payment cryptoasset" that will bring into scope "any cryptographically secured digital representation of monetary value which is, among other things stabilised by reference to one or more fiat currencies and/or is issued and used as a means of making payment transactions". This is intended to capture all stablecoins used as a means of payment that reference fiat currencies, including a single currency stablecoin or a stablecoin based on a basket of currencies. To facilitate a common industry methodology, the Treasury has decided to adopt the terminology of "stablecoin."

Although we await more definitive boundaries of tokens within scope, the Treasury has confirmed that certain stablecoins will be excluded. In particular, following feedback to its consultation, the Treasury now considers that asset-referenced stablecoins are unlikely to meet the minimum requirements that are expected from a token used in retail payments (and in some cases may already fall within the perimeter as specified investments).

The Treasury has also confirmed that, as with e-money, it will be a requirement that the stablecoin holder has a legal claim. In some arrangements, the stablecoin issuer may not offer holders a legal claim on the issuer, which means that the right of a customer to redeem the value of the token (or against a reserve of assets) may sit with a third party, or may not exist at all. Given the intention that the regime will provide a level of consistency between traditional e-money and stablecoins used as payment, the Treasury's view is that it would be unacceptable for there to be no legal claim at all. However, because the particular characteristics of stablecoins mean that the customer relationship may be with a third-party intermediary (such as a wallet), the Treasury considers that customers should generally be able to make a claim to either the stablecoin issuer or, where appropriate, the consumer facing entity. While the legal requirement would continue to sit with the issuer, requiring the issuer to fulfil directly the legal claim requirement is a high bar, which may only be necessary in systemic cases. The Treasury also intends to apply the statutory redemption rights set out in the Electronic Money Regulations 2011 (EMRs).

Regulatory framework

As proposed in its consultation, the Treasury will bring stablecoins within the regulatory perimeter primarily by amending and adapting the framework for payments and e-money established by the EMRs and Payment Service Regulations 2017 (PSRs). The overarching framework and key features of the EMRs regime will apply to stablecoin issuance, to ensure consistency with e-money regulation. The Treasury also confirms that the proposals for reform set out in its consultation on the Future Regulatory Framework Review will be extended to the regimes for payments and e-money, which means that we may see more detailed legislative solutions forthcoming to replace the direct regulatory requirements in retained EU law.

Wallet providers and other entities providing stablecoin activities for payments in the UK must be authorised by the FCA and would, if deemed systemic, also be subject to Bank of England supervision (see further below). Location requirements in the EMRs and PSRs will apply, once extended. Where stablecoins are brought into the existing regulatory perimeter covered by the FCA’s rules, the FCA's requirements will apply, including provisions requiring entities to be based in the UK. There may also be additional location requirements applied to systemic stablecoins under Bank of England supervision. The Treasury recognises that making further adjustments to location requirements for stablecoins may interact with the regulatory treatment of other payments-related activities, and invites further consideration from the industry through forthcoming consultations.

The Treasury intends to apply the safeguarding requirements under the EMRs to customer funds received in exchange for issuing a stablecoin. This means that each GBP 1 token issued will need to be safeguarded with GBP 1, and those funds cannot be used for any purpose (for example, lending).

The exemptions set out in the EMRs, including the limited network exclusion, will also broadly apply to stablecoins.

New regulated custodial activity

The Treasury will introduce a new regulated custodial activity to include the custody, or arranging the custody, of a token. This new activity is intended to capture wallets and other firms like exchanges offering similar services, and will 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. Exclusions are expected to apply, but those details have yet to be published by the Treasury.

The introduction of a new regulated custodial activity, while not unexpected (as indeed it was proposed in the Treasury's consultation), will introduce added complexity to an already complicated regulatory approach to cryptoassets, leaving the industry to navigate different and conflicting scopes of application along the different constituent frameworks applying to crypto. In particular, where businesses are providing crypto wallet services, those custody services fall within scope of the current AML/CTF registration regime under the Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 (MLRs) as well as the forthcoming stablecoin regulatory regime – but, importantly, will not fall within scope of the Treasury's forthcoming expansion of the financial promotion regime to crypto, as the Treasury has decided not to include custody within the list of controlled activities. 

Further, the regulatory regimes define cryptoassets differently, resulting in a lack of clarity for the industry trying to navigate the different requirements. The MLRs define “cryptoasset” for the purposes of the AML/CTF registration regime as a cryptographically secured digital representation of value or contractual rights that uses a form of DLT and can be transferred, stored or traded electronically; the scope of this definition includes exchange tokens used for speculative purposes, like Bitcoin and Ether, as well as NFTs. By contrast, the Treasury's stablecoin and financial promotion regimes deliberately omit any mention of DLT, in order to provide a measure of future-proofing. Further, the Treasury's stablecoin regime will apply, at least initially, only to fiat-referenced tokens used as a means of payment. Crypto businesses will need to carefully review how the different regulatory and marketing regimes will apply to their specific activities. 

For more on the expansion of the financial promotion regime to crypto, and the resulting complexities for crypto businesses, see our previous alert here.

Regulation of systemic stablecoin payment systems

The Treasury will extend the Bank of England's regulation of systemic payment systems under Part 5 of the Banking Act 2009 to include stablecoin activities, to apply in cases where the risks posed have the potential to be systemic - for entities authorised by the FCA and recognised under the Banking Act, the Bank of England will be the lead prudential authority. This is likely to be achieved by broadening the definition of a payment system to include arrangements that facilitate or control the transfer of, e.g., "digital settlement assets" (though the term is not yet settled), designed to capture stablecoin arrangements.

Systemic stablecoin payment systems will also be subject to competition regulation by the Payment Systems Regulator.

Other forthcoming measures

Alongside the stablecoin regime, a number of other important new measures and initiatives were announced by the Treasury and the FCA at FinTech Week.

The Treasury will consult later in 2022 on regulating a wider set of cryptoasset activities. The consultation will explicitly include other forms of cryptoassets used primarily as retail investments as well as decentralised finance (DeFi), among a range of other related topics. We may see the Treasury seek feedback in the consultation on the convergence of ESG and crypto – the Treasury confirms that the consultation will reflect the UK's green commitments and ensure that the approach is aligned to environmental objectives including the UK’s net zero target. In particular, there may be some movement from the Treasury to align crypto innovation in the UK with sustainability targets: the Treasury notes in this context that some stablecoins may be based on "proof of stake" blockchain systems and may not face energy-consumption issues which typically relate to the "mining" or proof-of-work process underpinning certain cryptoassets (and, further, welcomes the move to "proof of stake" processes). John Glen, Economic Secretary to the Treasury, confirmed in his keynote speech at FinTech Week that the UK government "will be looking closely at energy usage associated with certain crypto-technologies".

Further, as announced in 2021 the Treasury is developing a Financial Market Infrastructure (FMI) Sandbox (to be up and running in 2023) to support firms wanting to innovate, including by using tokenisation and DLT to provide FMI services.

Other measures and initiatives announced include:

• The UK government will explore how it might enhance the UK tax system to encourage further development of the cryptoasset market in the UK. This includes reviewing how DeFi loans and stakes are treated for tax purposes. The government will also consult on extending the scope of the Investment Manager Exemption to include cryptoassets.
• The UK government will initiate a research programme to explore the feasibility and potential benefits of using DLT for sovereign debt instruments.
• The Treasury will establish and chair a Cryptoasset Engagement Group, convening representatives from the FCA, the Bank of England and industry to advise the government on issues facing the cryptoasset sector.
• The FCA will hold its first ever "CryptoSprint" events (held in May and June 2022) with industry participants, seeking views directly from industry on key issues relating to the development of a future cryptoasset regime. Further, in September, the FCA will hold a joint TechSprint with the Payment Systems Regulator on Authorised Push Payment Fraud.
• The Law Commission has been asked to consider the legal status of Decentralised Autonomous Organisations, building on its work on smart contracts. 
• The Chancellor has commissioned the Royal Mint to create an NFT this summer, to serve as an emblem of the UK's ambitions to be the global hub for crypto.