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Fiat-backed stablecoins – Proposed UK regulatory regime

Proposals for a new regulatory regime for fiat-backed stablecoins and payments were set out by HM Treasury and UK financial service regulators late in 2023. Follow-up consultations are expected in the second half of 2024, with the new regime to be implemented in 2025.

In this article, our Financial Services legal experts look at what the future holds for the regulation of stablecoins in the UK.

How are stablecoins and fiat-backed stablecoins defined?

Stablecoins are a category of crypto-assets that aim to maintain a stable value relative to a specified asset or basket of assets, offering perceived stability compared to the high volatility of unbacked crypt-assets. Fiat-backed stablecoins are a specific type of stablecoin that seeks to maintain a stabilised value by reference to, and potentially holding one or more specified fiat currencies.

The Financial Conduct Authority (FCA) distinguishes between regulated stablecoins, which are issued by firms authorised by the FCA within the UK, and approved stablecoins, which are issued from outside the UK (overseas stablecoins). Stablecoins have various use cases, primarily for purchasing or selling other crypto-assets or facilitating cross-border payments such as remittances.

What distinguishes fiat-backed stable coins from other cryptocurrencies?

Although not defined in the consultation paper, fiat money can be understood as currency issued by government decree that is not backed by a precious metal such as gold or silver.

Cryptoassets are digital assets implemented using blockchain or distributed ledger technology (DLT). While Bitcoin was the first cryptocurrency, its value is not pegged to the value of another asset.

Leading examples of fiat-backed cryptocurrencies are Tether and USD Coin, which are each pegged to the US dollar. The key advantage of pegging a crypto asset to a government-issued currency in this way is its perceived stability compared to the volatility in the value of cryptoassets that are not pegged.

How are fiat-backed stable coins currently regulated?

The existing UK regulatory regime for stablecoins is at an early stage of development. The UK does not yet have a fully developed regulatory regime for cryptoassets, compared to competing jurisdictions such as Switzerland or Singapore. The government’s phased approach is intended to allow firms to innovate.

Currently, the FCA’s remit for stablecoins is limited to anti-money laundering and counter-terrorist financing, as well as the financial promotion of cryptoassets. The relevant regulations are:

  • The Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 (SI 2017/692) (MLRs), as amended, under which 42 FCA firms were registered in September 2023. Several other firms withdrew their applications and/or ceased to undertake cryptoasset business in the UK.

Fiat-backed stablecoins are currently regulated in the UK under both of these statutory instruments, which represents a fairly light-touch approach.

What changes to FCA regulation are proposed in the UK?

The FCA discussion paper sets out several proposals for regulating fiat-backed stablecoins, including:

  • Backing assets and redemption
    Assets backing stablecoins would need to be government treasury debt instruments with maturities of one year or less. Remuneration or interest payments to consumers would not be permissible.

    Holders would need to be able to convert their stablecoin into fiat currency at par value at all times and by the end of the next business day. Terms and conditions of a regulated stablecoin would need to be reasonable and proportionate, complying with other laws such as the Consumer Rights Act 2015. Information about the stablecoins would need to be communicated clearly in line with the Consumer Duty and financial promotions rules.
  • CASS and Custody
    The FCA Client Assets regime (CASS) would apply, with a statutory trust to safeguard and segregate client assets from a firm’s assets. Accurate books and records would be required, with daily reconciliations. A CASS oversight officer would need to be accountable for overseeing the backing assets, with monthly reports to the FCA.

    Cryptoasset custodians may be prohibited from using clients’ cryptoassets for other purposes such as rehypothecation, which is the re-use of assets held as collateral. Custodians may need to disclose explicitly in client agreements their safeguarding controls and liability if at fault for loss. There could be new diligence requirements for the use of sub-custodians.
  • Organisational requirements
    The FCA’s Senior Management Arrangements, Systems and Controls (SYSC) sourcebook would apply to regulated stablecoin issuers and custodians. FCA rules on operational resilience could also apply, as well as requirements for effective cyber resilience practices. Firms would need to have systems and controls to counter financial crime. A money laundering reporting officer (MLRO) would be needed, providing annual and ad hoc financial crime reports. 

    The Senior Managers Regime and Certification Regime (SM&CR), as well as other FCA conduct rules would apply.
  • Conduct of business and consumer redress
    The FCA Principles for Businesses apply to every regulated firm, including Principle 12 on the Consumer Duty e.g., firms would be expected to offer fair prices and value to consumers. Firms would be subject to the Conduct of Business Sourcebook (COBS). For example, COBS restricts inducements firms can accept, such as commissions. Conflicts of interest rules would also apply.

    Complaints handling rules would apply. Customers would have access to the Ombudsman Service; however, the Financial Services Compensation Scheme would not apply.
  • Prudential requirements
    A dedicated new prudential sourcebook for regulated stablecoin issuers and custodians is proposed: CRYPTOPRU. New capital requirements would be established, together with new minimum liquidity requirements.
  • Resolution on failure
    CASS rules on the safeguarding of regulated stablecoin backing assets would apply on the failure of a firm, with some adaptations. However, off-chain post-failure secondary trading would not be prohibited.
  • Payments
    HM Treasury has proposed extending the Payment Services Regulations 2017 (SI 2017/752) (PSRs) to capture stablecoins used for payment. Existing conduct rules for payment service providers in the PSRs would apply to certain stablecoin payments activities and ancillary service activities. The Money Laundering Regulations also apply to payment services regulated under the PSRs.

How might the proposed UK regulations impact the cryptocurrency market?

Many in the industry have long been calling for increased regulation, as it gives a product a stamp of some authority. Regulation is generally thought to mitigate the risk of contagion in financial markets, such as was evident in the so-called “crypto winter” of 2022-23. Many think regulation will increase consumer confidence in investing in cryptoassets.

Clearly, the scope of the proposed regulatory changes will impact the cryptocurrency market heavily. It will take firms issuing and safeguarding stablecoins considerable time to review their business models for compliance with the new regime, enhance governance and risk management.

For example, if fiat-backed stablecoins are limited to government treasury debt instruments, this will impact those stablecoins that are currently backed by other assets such as commercial paper, certificates of deposit or money market funds. Similarly, movement to same-day reconciliations and next-day redemptions will challenge some stablecoin firms.

Timing these changes is important though, as these regulatory proposals are at an early stage, awaiting a further round of consultation by the FCA before any legal instruments are drafted. Now is the time for planning the approach, but not necessarily yet making wholesale changes to the business.

Harper James’ Financial Services solicitors are on hand to assist with tailored advice on any new requirements and how they might impact your business.

About our expert

Charles Rogers

Charles Rogers

Senior Financial Services Solicitor (Scottish Qualified)
Charles is a specialist in financial regulation, having qualified as a solicitor in Scotland in 2014. He advises financial institutions, their clients, and services providers on both regulated and unregulated financial services. This includes drafting and reviewing agreements; providing legal opinions; contributing to disputes advice; and assisting with applications to—as well as correspondence with—the financial regulator and ombudsman.

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