The Treasury’s Response to the Need to Regulate Stablecoin

Syed Rahman of Rahman Ravelli details the main issues to arise from HM Treasury’s consultation on cryptoassets and stablecoins.

HM Treasury launched a Consultation and Call for Evidence in 2021 on the regulatory approach to cryptoassets and stablecoins. The consultation was an understandable response to the need to ensure the creation of a regulatory framework that would ensure the benefits and innovation associated with such assets while also protecting consumers and the integrity of the market.

So far, the UK government is aiming for an approach to regulation that will be proportionate to the risks that have been identified and capable of responding to any future developments.

This emphasis on any regulatory framework needing to be flexible enough to allow for rules to be adapted to reflect market changes is logical. The consultation draws attention to stablecoins. This is not surprising given that they are the more recently-developed cryptoassets, may well become a common payment feature, could be used extensively in cross-border transactions and look to be playing a notable part in the growth of decentralised finance (DeFi). The government’s aim of removing risks, shortcomings in regulation and market abuse regarding stablecoins makes sense.

Treasury Response

In April this year, the Treasury published its Response to the Consultation and Call for Evidence on the regulatory approach to cryptoassets and stablecoins. The response is, in effect, the UK approach to stablecoin regulation.

The increasing prominence of stablecoins has prompted the government to  consider what it can do to remove (or at least reduce) the risks associated with them. The response makes it clear that the government wants to see stablecoins used as a means of payment within the UK regulatory perimeter. It intends to achieve this by amending the Electronic Money Regulations 2011 and the Payment Services Regulations 2017, as the UK currently has no regime for the regulation of stablecoins.

There appears to be an intention to put in place an amended e-money framework that will cover the official issuing of stablecoins and the relevant wallets and custody services, ensure convertibility into fiat currency and facilitate simultaneous payments. This will be backed by Financial Conduct Authority (FCA) rules and guidance.

The main points of the Treasury Response are:

• Issuers of stablecoins will have to be authorised by the FCA. The government has made clear that the definition of stablecoins will be cryptoassets which are a representation of monetary value, stabilised by reference to one or more fiat currencies used as a means of making payment transactions. This definition is unlikely to cover stablecoins that reference commodities or that stabilise algorithmically (unless such stabilisation references a fiat currency).
• Custodial wallet providers will be regulated - due to their prominence in DeFi – and brought under the existing e-money and payment services regimes. The government only intends to regulate exchanges regarding their provision or arrangement for custody of payment cryptoassets. While operating an exchange will not have to be authorised in itself, the fact that many will provide such services will make authorisation necessary.
• The maintenance and management of reserves, safeguarding, systems and controls and conduct of business requirements will all be areas where the compliance requirements will be strict.

The FCA authorisation will apply to:

• The issue, creation or destruction of asset-linked tokens.
• The issue, creation or destruction of single fiat-linked tokens.
• Token issuers’ and payment systems operators’ management of the reserve assets that are backing the value of a stable token and their provision of custody/trust services for those assets to ensure stabilisation of the stable token.
• The management of tokens on behalf of owners, including the storage of private keys provided by wallets and some exchanges.
• The conducting of transactions by token issuers, wallets and exchanges for another party.
• The purchase or exchange of a stable token with fiat money carried on by token issuers, wallets and exchanges. 

It will not apply to:

• The authorising or verifying the validity of transactions and records by token issuers or payment systems operators.
• The providing of services or support to facilitate participants’ access to the network or underlying infrastructure.
• The conduct of designated dealers, payment system operators and wallets in ensuring the correct and final settlement of transactions while limiting counterparty and default risk.
• There will be an extension of Part 5 of the Banking Act 2009 to cover systemic stablecoin payment systems. The existing criteria for payment systems will be broadened to include stablecoins that perform a retail or wholesale function. Doing this will enable the Bank of England (as lead prudential authority) and the FCA to directly supervise them. Any stable token launched that has the potential to be systemic would have to be covered by the enhanced requirements that apply to firms that reach systemic status and which are grounded in the Principles for Financial Market Infrastructures (PFMIs) developed by the Committee on Payments and Market Infrastructures (CPMI) and the International Organization of Securities Commissions (IOSCO). Factors determining whether this would be necessary would include the stable token’s potential user base, the amount of transactions and avenues for the acquisition of customers.
• A widening of the scope of the Financial Services (Banking Reform) Act 2013 so that stablecoin payment systems are subject to the appropriate competition regulation by the Payment Systems Regulator (PSR).

Conclusion

Without even considering the individual aspects of the Treasury’s response, the fact that there has been a formal consultation exercise is clear proof that stablecoin requires some form of regulation that is appropriate to its role in the financial system.

While it could be argued that, at this stage, nothing definite has been agreed, it certainly appears that measures will be introduced in the near future. There are now higher than ever levels of scrutiny on stablecoin. Regardless of what the precise outcome of this proves to be, there is little doubt that those who do operate in this area will need to reassess their existing arrangements and ensure they do all they have to do to comply with any regulatory changes that are eventually introduced.