On 4 April 2022, Her Majesty’s Treasury (the Treasury) published its response (the Response) to its consultation and call for evidence on the UK’s regulatory approach to cryptoassets, stablecoins and distributed ledger technology in financial markets (the Consultation).
UK Government’s Approach to Stablecoins
The Response set out the UK Government’s plans to undertake the following:
- Bring certain stablecoins when used as means of payment into scope of the UK’s payment services and electronic money regulatory perimeter to be supervised by the Financial Conduct Authority (FCA);
- Subject stablecoin issuers and service providers to the prudential supervision of the Bank of England when the stablecoins are considered systemic payment systems; and
- Ensure that stablecoin-based payment systems, whether systemic or not, are subject to appropriate competition regulation from the Payment Systems Regulator.
The industry reaction to the Treasury’s Response has largely been positive. For example, Global Digital Finance welcomed the inclusion of stablecoins in the regulatory perimeter noting that this will “lead to greater consumer confidence and protections”.
Amending legislation and new regulatory rules to effect these changes have yet to be published. The Response does not state when these changes will be publicised.
Ambition to make the UK a global hub for cryptoasset technology and investment
In making the announcement, the UK Government also announced its ambition to makef the UK a global hub for cryptoasset technology and investment. In addition to the approach set out in the Response, the UK Government also announced that it would be:
- introducing a financial market infrastructure sandbox to enable firms to experiment and innovate with new ways of settling transactions using digital ledger technology;
- establishing a Cryptoasset Engagement Group to work more closely with the industry;
- exploring ways of enhancing the competitiveness of the UK tax system to encourage further development of the cryptoasset market, in particular looking at the tax treatment of decentralised finance including the treatment of cryptoasset lending;
- and working with the Royal Mint on issuing a Non-Fungible Token (NFT) in Summer 2022.
The change of tone coming from the UK Government is significant. Whereas recently the focus has been on warning consumers, putting in place anti-money laundering and counter-terrorism protections and distinguishing the cryptoasset ecosystem from the regulated financial services sector, now the UK Government is aiming to integration a part of the cryptoasset ecosystem into the UK regulatory framework.
In announcing the changes, the Chancellor of the Exchequer Rishi Sunak stated:
“It’s my ambition to make the UK a global hub for cryptoasset technology, and the measures we’ve outlined today will help to ensure firms can invest, innovate and scale up in this country.
We want to see the businesses of tomorrow – and the jobs they create - here in the UK, and by regulating effectively we can give them the confidence they need to think and invest long-term.
This is part of our plan to ensure the UK financial services industry is always at the forefront of technology and innovation.”
The Treasury is also proposing to consult on a broader approach to cryptoassets (beyond stablecoins used as a means of payment) later in 2022. This consultation may address asset referenced tokens beyond the stablecoins being brought into scope of the UK regulatory framework as outlined in the Response. This consultation will also indicate whether the UK will be taking a similar approach as the EU to the regulation of cryptoassets broadly as seen under the Proposal for the Regulation of Markets in Cryptoassets (otherwise known as MiCA).
Stablecoin Market Development
The need for an appropriate UK regulatory response has largely been driven by the development of the market for stablecoins.
According to the Financial Stability Board’s Progress Report on the implementation of high-level recommendations on the regulation, supervision and oversight of global stablecoin arrangements, the total market capitalisation of stablecoins stood at around $123 billion in September 2021.
The largest stablecoin is Tether, with a reported market capitalisation of $68 billion. In the past year, other stablecoins like USD Coin and Binance USD have also reached significant market capitalisations.
Meta Platforms (formerly known as Facebook Inc.) had also planned on launching a stablecoin initially known as Libra but then subsequently rebranded as Diem. The launch did not proceed and the assets of the Diem Associate and intellectual property were subsequently sold.
Incorporating Stablecoin activities into Payment Services and Electronic Money Laws
In the Response, the UK Government details that it will include a new definition of a “payment cryptoasset” which will mean any cryptographically secure 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 means of making payment transactions.
This will encompass stablecoins that reference fiat currencies, including a single currency stablecoin or a stablecoin based on a basket of currencies. It would also include stablecoins that reference another stablecoin linked to fiat money or any instrument.
Notably, this definition would not include other stablecoin models which stabilise their value by reference to other such assets like commodities or by the use of algorithms. In the Treasury’s view, these types of stablecoins do not offer sufficient price stability in order to be used for payments.
The Response acknowledged responses to the Consultation which noted this could create a regulatory arbitrage opportunity between regulated and unregulated stablecoins.
Firms issuing these payment cryptoassets and/or providing services in connection with them such as providing custody wallets will be subject to the UK’s Payment Services Regulations 2017 (PSRs) and the Electronic Money Regulations 2011 (EMRs). The PSRs and EMRs transpose the requirements of the second Payment Services Directive (EU) 2015/2366 and second Electronic Money Directive 2009/110/EC in the UK and remain applicable post-Brexit.
Most respondents to the Consultation stated that the PSRs and EMRs offer a good basis for the regulation of stablecoins, particularly for those used in retail payments. Respondents also noted that there are risks in retrofitting existing legislation on the basis that it may be difficult to future-proof these laws to encompass new innovations in the market and the PSRs and EMRs may be inappropriate for tokens used in the wholesale market.
Nevertheless, the UK Government proposes to apply the requirements of the PSRs and EMRs to payment cryptoassets including obligations to obtain authorisation, orderly failure and insolvency requirements, safeguarding customer funds pound for pound, having regulatory capital in place and having appropriate systems, controls, risk management and governance.
The UK Government also proposes to update the definition of electronic money in the EMRs. In some stablecoin arrangements, the stablecoin issuer may not offer holders a legal claim on the issuer. This means that the right of a customer to redeem the value of the token may sit with a third party or not exist at all. This differs to the current definition of e-money which requires the holder to have a claim on the issuer.
In the Response, the UK Government states that it would be unacceptable for a holder not to have a legal claim so the UK Government will amend the definition to allow a customer to have a claim either against the stablecoin issuer or a consumer facing entity such as a wallet provider. To this end, the UK Government will introduce a new regulated custodial activity which would require providers to be authorised by the FCA. The FCA will set the regulatory rules applicable to these stablecoin custodians.
Regulation by the Bank of England and the Payment Systems Regulator
Currently, the Bank of England regulates and supervises systemic payment systems and service providers for those systems, following the making of a recognition order by the Treasury under Part 5 of the Banking Act 2009. The criteria for recognition of being “systemic” include the ability of the payment system to disrupt the UK financial system as well as factors like volume and value of transactions. These payment systems include the major international card schemes like Mastercard and VISA as well as certain UK based payment systems like BACS and the Faster Payments Service.
Consistent with the UK Government’s approach that systems with the same risks should be subject to the same regulatory framework, the UK Government has stated the Banking Act 2009 should be updated to allow the Treasury to designate stablecoin based payment systems that meet the criteria to be supervised by the Bank of England.
Whilst respondents to the Consultation stated that it is unlikely in the near-term that any such systems will become systemically important, the UK Government is pushing ahead with this change to future-proof the regulatory framework.
The UK Government is also amending the Financial Services (Banking Reform) Act to ensure that stablecoin-based systems (whether systemic or not) are supervised by the Payment Systems Regulator from a competition standpoint. The Payment Systems Regulator will be able to supervise not only the issuers of digital settlement assets but also wallets and other entities such as exchanges and those that manage stablecoin reserves.
Systemic Stablecoin Failure
In the Response, the UK Government also states that it will make appropriate amendments to the financial market infrastructure special resolution regime and clarify that it, rather than the regime that applies to payments and electronic money, will apply in the event of a systemic stablecoin payment system failure.
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